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Conditional Evaluation of Exchange Rate Predictive Ability in Long Run Regressions

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  • Pablo Pincheira

Abstract

In this paper we evaluate exchange rate predictability using a new framework developed by Giacomini and White (2004). In this new framework we test for conditional predictive ability rather than for unconditional predictive ability, which has been the usual approach thus far. Using several shrinkage based forecasting methods, including new methods proposed here, we evaluate conditional predictability of five bilateral exchange rates at differing horizons. Our results indicate that for most currencies a random walk would not be the best forecasting method in a real time forecasting exercise, at least for some predictive horizons. We also show that our proposed shrinkage methods in general perform on par with Bayesian shrinkage and ridge regressions, and sometimes they even perform better.

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Bibliographic Info

Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 378.

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Date of creation: Nov 2006
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Handle: RePEc:chb:bcchwp:378

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  1. Diebold, Francis X & Mariano, Roberto S, 1995. "Comparing Predictive Accuracy," Journal of Business & Economic Statistics, American Statistical Association, vol. 13(3), pages 253-63, July.
  2. Robert B. Litterman, 1985. "Forecasting with Bayesian vector autoregressions five years of experience," Working Papers 274, Federal Reserve Bank of Minneapolis.
  3. Cheung, Yin-Wong & Chinn, Menzie & Garcia Pascual, Antonio, 2003. "Empirical Exchange Rate Models of the Nineties: Are Any Fit to Survive?," Santa Cruz Center for International Economics, Working Paper Series qt5fc508pt, Center for International Economics, UC Santa Cruz.
  4. Chinn, Menzie D. & Meese, Richard A., 1995. "Banking on currency forecasts: How predictable is change in money?," Journal of International Economics, Elsevier, vol. 38(1-2), pages 161-178, February.
  5. Kilian, Lutz, 1999. "Exchange Rates and Monetary Fundamentals: What Do We Learn from Long-Horizon Regressions?," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 14(5), pages 491-510, Sept.-Oct.
  6. Mark, Nelson C, 1995. "Exchange Rates and Fundamentals: Evidence on Long-Horizon Predictability," American Economic Review, American Economic Association, vol. 85(1), pages 201-18, March.
  7. Kenneth D. West, 1994. "Asymptotic Inference About Predictive Ability," Macroeconomics 9410002, EconWPA.
  8. Ronald MacDonald & Ian W. Marsh, 1997. "On Fundamentals And Exchange Rates: A Casselian Perspective," The Review of Economics and Statistics, MIT Press, vol. 79(4), pages 655-664, November.
  9. McCracken, Michael W & Sapp, Stephen G, 2005. "Evaluating the Predictability of Exchange Rates Using Long-Horizon Regressions: Mind Your p's and q's!," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(3), pages 473-94, June.
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