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Modelling and Forecasting the Indian Re/US Dollar Exchange Rate

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  • Pami Dua

    (Department of Economics, Delhi School of Economics, Delhi, India)

  • Rajiv Ranjan

    (Reserve Bank of India, India)

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Abstract

This paper develops vector autoregressive and Bayesian vector autoregressive models to forecast the Indian Re/US dollar exchange rate which is governed by a managed floating exchange rate regime. It considers extensions of the monetary model that include the forward premium, capital inflows, volatility of capital flows, order flows and central bank intervention. The study finds that the monetary model generally outperforms the naïve model. It also finds that forecast accuracy can be improved by extending the monetary model to include forward premium, volatility of capital inflows and order flow. Information on intervention by the central bank also helps to improve forecasts at the longer end. The study also reports that the Bayesian vector autoregressive models generally outperform their corresponding VAR variants.

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Bibliographic Info

Paper provided by Centre for Development Economics, Delhi School of Economics in its series Working papers with number 197.

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Length: 47 pages
Date of creation: Feb 2011
Date of revision:
Handle: RePEc:cde:cdewps:197

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Keywords: exchange rate; monetary model; VAR and Bayesian VAR models;

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  1. Hoidal Bjonnes, Geir & Rime, Dagfinn, 2003. "Dealer Behavior and Trading Systems in Foreign Exchange Markets," SIFR Research Report Series 17, Institute for Financial Research.
  2. Pasquale Della Corte & Lucio Sarno & Ilias Tsiakas, 2009. "An Economic Evaluation of Empirical Exchange Rate Models," Review of Financial Studies, Society for Financial Studies, vol. 22(9), pages 3491-3530, September.
  3. Christopher J. Neely, 2005. "An analysis of recent studies of the effect of foreign exchange intervention," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 685-718.
  4. Artis, M. J. & Zhang, W., 1990. "BVAR forecasts for the G-7," International Journal of Forecasting, Elsevier, vol. 6(3), pages 349-362, October.
  5. Christopher J. Neely, 2001. "The practice of central bank intervention: looking under the hood," Review, Federal Reserve Bank of St. Louis, issue May, pages 1-10.
  6. Harvey, David & Leybourne, Stephen & Newbold, Paul, 1997. "Testing the equality of prediction mean squared errors," International Journal of Forecasting, Elsevier, vol. 13(2), pages 281-291, June.
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