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Long horizon predictability of exchange rates: Is it for real?

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Author Info
Jan J. J. Groen () (Tinbergen Institute, Erasmus University Rotterdam, P.O. Box 1738, NL-3000 DR Rotterdam, The Netherlands)

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Abstract

This paper reexamines recent results on the predictability of nominal exchange rate returns by means of fundamental models. Using a monthly sample of the post-Bretton Woods period we show that the in-sample fit between long-horizon exchange rate returns and various models is not significant if we correct for the persistence that is caused by overlapping data and spurious regression phenomena. The long horizon out-of-sample predictive power of the fundamental exchange rate models is found to be very weak. This is especially the case when we conduct the out-of-sample forecasting tests for a longer time span than that of earlier papers. We show that this failure in forecasting performance, resulting from extending the time span, is due to the absence of cointegration between exchange rates and structural exchange rate models.

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Publisher Info
Article provided by Springer in its journal Empirical Economics.

Volume (Year): 24 (1999)
Issue (Month): 3 ()
Pages: 451-469
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Handle: RePEc:spr:empeco:v:24:y:1999:i:3:p:451-469

Note: received: September 1997/final version received: November 1998
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Related research
Keywords: Exchange rates · forecasting · pooled forecasting · random walk;

Other versions of this item:

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
G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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  1. Todd E. Clark & Michael W. McCracken, 2001. "Evaluating long-horizon forecasts," Research Working Paper RWP 01-14, Federal Reserve Bank of Kansas City. [Downloadable!]
  2. Phornchanok Cumperayot, 2003. "Dusting off the Perception of Risk and Returns in FOREX Markets," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
  3. Nelson Mark & Donggyu Sul, 1998. "Norminal Exchange Rates and Monetary Fundamentals: Evidence from a Small Post-Bretton Woods Panel," Working Papers 98-19, Ohio State University, Department of Economics. [Downloadable!]
    Other versions:
  4. Westerlund, Joakim & Basher, Syed A., 2006. "Can Panel Data Really Improve the Predictability of the Monetary Exchange Rate Model?," MPRA Paper 1229, University Library of Munich, Germany. [Downloadable!]
    Other versions:
  5. Carriero, Andrea & Kapetanios, George & Marcellino, Massimiliano, 2008. "Forecasting Exchange Rates with a Large Bayesian VAR," CEPR Discussion Papers 7008, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  6. Jan J J Groen & Ravi Balakrishnan, . "Asset price based estimates of sterling exchange rate risk premia," Bank of England working papers 250, Bank of England. [Downloadable!]
    Other versions:
  7. Jonathan H. Wright, 2003. "Bayesian Model Averaging and exchange rate forecasts," International Finance Discussion Papers 779, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
    Other versions:
  8. Jan J J Groen & Clare Lombardelli, . "Real exchange rates and the relative prices of non-traded and traded goods: an empirical analysis," Bank of England working papers 223, Bank of England. [Downloadable!]
  9. J.J.J. Groen, 2001. "(EURO) Exchange Rate Predictability and Monetary Fundamentals in a Small Multi-Country Panel," WO Research Memoranda (discontinued) 664, Netherlands Central Bank, Research Department. [Downloadable!]
  10. Christopher J. Neely & Lucio Sarno, 2002. "How well do monetary fundamentals forecast exchange rates?," Working Papers 2002-007, Federal Reserve Bank of St. Louis. [Downloadable!]
    Other versions:
  11. Guy Meredith, 2003. "Medium-Term Exchange Rate Forecasting: What Can We Expect?," IMF Working Papers 03/21, International Monetary Fund. [Downloadable!]
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