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Nonlinear exchange rate predictability

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  • López-Suárez, Carlos Felipe
  • Rodríguez-López, José Antonio

Abstract

We study whether the nonlinear behavior of the real exchange rate can help us account for the lack of predictability of the nominal exchange rate. We construct a smooth nonlinear error-correction model that allows us to test the hypotheses of nonlinear predictability of the nominal exchange rate and nonlinear behavior on the real exchange rate in the context of a fully specified cointegrated system. Using a panel of 19 countries and three numeraires, we find evidence of nonlinear predictability of the nominal exchange rate and of nonlinear mean reversion of the real exchange rate. Out-of-sample Theil's U -statistics show a higher forecast precision of the nonlinear model than the one obtained with a random walk specification. Although the robustness of the out-of-sample results over different forecast windows is somewhat limited, we are able to obtain significant predictability gains--from a parsimonious structural model with PPP fundamentals--even at short-run horizons.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 30 (2011)
Issue (Month): 5 (September)
Pages: 877-895

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Handle: RePEc:eee:jimfin:v:30:y:2011:i:5:p:877-895

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Web page: http://www.elsevier.com/locate/inca/30443

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Keywords: Exchange rates Predictability Nonlinearities Purchasing power parity;

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Cited by:
  1. Michele Ca’ Zorzi & Michal Rubaszek, 2012. "Real exchange rate forecasting: a calibrated half-life PPP model can beat the random walk," National Bank of Poland Working Papers 123, National Bank of Poland, Economic Institute.

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