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Balassa-Samuelson Theory and Predictability of the US/UK Real Exchange Rate

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  • Kim Chung-Han

Abstract

This paper performs a theory-based forecast of the US/UK real exchange rate. The theory is the Balassa-Samuelson hypothesis that productivity differentials between two countries would determine long-run movements of real exchange rates. The relative income and real exchange rate set a bivariate system, which considers the heteroskedasticity in the real exchange rate movements. The model, to which the Kalman filter and Markov-switching algorithm are applied, is compared with the random walk model and reports significant improvements in forecasting in the medium and long term. [C53, F31]

Suggested Citation

  • Kim Chung-Han, 2000. "Balassa-Samuelson Theory and Predictability of the US/UK Real Exchange Rate," International Economic Journal, Taylor & Francis Journals, vol. 14(3), pages 101-121.
    • Handle: RePEc:taf:intecj:v:14:y:2000:i:3:p:101-121
    DOI: 10.1080/10168730000000031
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