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Time-varying Cointegration Models and Exchange Rate Predictability in Korea

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  • Park, Soo Kyung
  • Park, Choel Beom

Abstract

We examine the validity of popular exchange rate models such as the purchasing power parity (PPP) hypothesis and the monetary model for Korean won/US dollar exchange rate. Various specification tests demonstrate that Korean data are more favorable for both models based on time-varying cointegration coefficients as compared to those based on constant cointegration coefficients. When the abilities to predict future exchange rates between those models based on timevarying cointegration coefficients are compared, an in-sample analysis shows that the time-varying PPP (monetary model) has better predictive power over horizons shorter (longer) than one year. Results from an out-of-sample analysis indicate that the time-varying PPP outperforms models based on constant cointegration coefficients when predicting future exchange rate changes in the long run.

Suggested Citation

  • Park, Soo Kyung & Park, Choel Beom, 2015. "Time-varying Cointegration Models and Exchange Rate Predictability in Korea," KDI Journal of Economic Policy, Korea Development Institute (KDI), vol. 37(4), pages 1-20.
    • Handle: RePEc:zbw:kdijep:v:37:y:2015:i:4:p:1-20
    DOI: 10.23895/kdijep.2015.37.4.1
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    More about this item

    Keywords

    Exchange rate; Monetary model; Predictability; Purchasing power parity; Timevarying cointegration;
    All these keywords.

    JEL classification:

    • F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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