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Should We Trust the Empirical Evidence from Present Value Models of the Current Account?

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  • Mercereau, Benoît
  • Miniane, Jacques Alain
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    Abstract

    The present value model of the current account has been very popular, as it provides an optimal benchmark to which actual current account series have often been compared. We show why persistence in observed current account data makes the estimated optimal series very sensitive to small-sample estimation error, making it almost impossible to determine whether the consumption-smoothing current account tracks the actual current account closely, or not closely at all. Moreover, the standard Wald test of the model will falsely accept or reject the model with substantial probability. Monte Carlo simulations and estimations using annual and quarterly data from five OECD countries strongly support our predictions. In particular, we conclude that two important consensus results in the literature - that the optimal series is highly correlated with the actual series, but substantially less volatile - are not statistically robust. --

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    File URL: http://dx.doi.org/10.5018/economics-ejournal.ja.2008-34
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    File URL: http://econstor.eu/bitstream/10419/27518/1/economics_2008-34.pdf
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    Bibliographic Info

    Article provided by Kiel Institute for the World Economy in its journal Economics: The Open-Access, Open-Assessment E-Journal.

    Volume (Year): 2 (2008)
    Issue (Month): 34 ()
    Pages: 1-36

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    Handle: RePEc:zbw:ifweej:7401

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    Related research

    Keywords: Currrent account; present value model; model evaluation;

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    1. Agenor, Pierre-Richard & Bismut, Claude & Cashin, Paul & McDermott, C. John, 1999. "Consumption smoothing and the current account: evidence for France, 1970-1996," Journal of International Money and Finance, Elsevier, vol. 18(1), pages 1-12, January.
    2. Geert Bekaert & Robert J. Hodrick, 2000. "Expectations Hypotheses Tests," NBER Working Papers 7609, National Bureau of Economic Research, Inc.
    3. Bergin, Paul R & Sheffrin, Steven M, 2000. "Interest Rates, Exchange Rates and Present Value Models of the Current Account," Economic Journal, Royal Economic Society, vol. 110(463), pages 535-58, April.
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