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Forecasting the USD/COP Exchange Rate: A Random Walk a Variable Drift

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Author Info
Peter Rowland ()
Abstract

This study develops three exchange rate models as well as a simple statistical model defined as a random walk with a variable drift. The exchange rate models all use the purchasing power parity hypothesis to account for the long-term relationships between prices and the exchange rate, together with error correction models to represent any shortterm dynamics. The models are estimated for the USD/COP rate of exchange, and their forecast performance is compared to that of a simple random walk as well as to that of the random walk with a variable drift term.Two of the models are shown to outperform the simple random walk on the 12 and 24 -months forecasting horizont. However, all the models are outperformed by the random walk with a variable drift, where the drift term is estimated using a Kalman filter. The results suggest that fundamnetal modles might only be a useful tool for forecasting of the exchange rate in the very long run.

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Paper provided by Banco de la Republica de Colombia in its series Borradores de Economia with number 253.

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Handle: RePEc:bdr:borrec:253

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  2. Frankel, Jeffrey A, 1979. "On the Mark: A Theory of Floating Exchange Rates Based on Real Interest Differentials," American Economic Review, American Economic Association, vol. 69(4), pages 610-22, September. [Downloadable!] (restricted)
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  6. Sweeney, Richard J, 1986. " Beating the Foreign Exchange Market," Journal of Finance, American Finance Association, vol. 41(1), pages 163-82, March. [Downloadable!] (restricted)
  7. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December. [Downloadable!] (restricted)
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  11. Frankel, Jeffrey A & Froot, Kenneth A, 1990. "Chartists, Fundamentalists, and Trading in the Foreign Exchange Market," American Economic Review, American Economic Association, vol. 80(2), pages 181-85, May. [Downloadable!] (restricted)
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  13. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June. [Downloadable!] (restricted)
  14. Richard Meese & Kenneth Rogoff, 1983. "The Out-of-Sample Failure of Empirical Exchange Rate Models: Sampling Error or Misspecification?," NBER Chapters, in: Exchange Rates and International Macroeconomics, pages 67-112 National Bureau of Economic Research, Inc. [Downloadable!]
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  15. Rudiger Dornbusch, 1985. "Purchasing Power Parity," NBER Working Papers 1591, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  16. Cumby, Robert E. & Modest, David M., 1987. "Testing for market timing ability : A framework for forecast evaluation," Journal of Financial Economics, Elsevier, vol. 19(1), pages 169-189, September. [Downloadable!] (restricted)
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  19. Taylor, Mark P. & Allen, Helen, 1992. "The use of technical analysis in the foreign exchange market," Journal of International Money and Finance, Elsevier, vol. 11(3), pages 304-314, June. [Downloadable!] (restricted)
  20. Johansen, Soren, 1991. "Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models," Econometrica, Econometric Society, vol. 59(6), pages 1551-80, November. [Downloadable!] (restricted)
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