Exchange rates and individual good's price misalignment: Evidence of long-horizon predictability
AbstractAlthough purchasing-power-parity fundamentals, in general, have only weak predictability, currency misalignment may be indicated by price differentials for some individual goods, which could then have predictive power for subsequent re-evaluation of the nominal exchange rate. We collect good-level price data to construct deviations from the law of one price and examine the resulting price-misalignment model's predictive power for the nominal exchange rates between the U.S. dollar and two other currencies: the Japanese yen and the U.K. pound. We find that the slope coefficients and R-squares of in-sample forecasting regressions for almost all goods in our data increase with the forecast horizon for the bilateral exchange rates between the U.S. dollar and the Japanese yen and the U.S. dollar and the U.K. pound. The results of tests for out-of-sample superior predictive ability suggest that our price-misalignment model outperforms a random walk model either with or without drift for the U.S. dollar vis-à-vis the Japanese yen at the 5 percent level of significance over long horizons.
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Bibliographic InfoArticle provided by Elsevier in its journal Journal of International Money and Finance.
Volume (Year): 32 (2013)
Issue (Month): C ()
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Web page: http://www.elsevier.com/locate/inca/30443
Exchange rates; Price misalignments; In-sample forecasting; Out-of-sample forecasting; Superior predictive ability test;
Find related papers by JEL classification:
- F31 - International Economics - - International Finance - - - Foreign Exchange
- F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation: Models and Applications
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