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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Find related papers by JEL classification: C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Bayesian Analysis C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation and Testing F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
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