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Conditional Evaluation of Exchange Rate Predictive Ability in Long Run Regressions

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Author Info
Pablo Pincheira

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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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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. Robert B. Litterman, 1985. "Forecasting with Bayesian vector autoregressions five years of experience," Working Papers 274, Federal Reserve Bank of Minneapolis. [Downloadable!]
    Other versions:
  2. Todd E. Clark & Michael W. McCracken, 2001. "Evaluating long-horizon forecasts," Research Working Paper RWP 01-14, Federal Reserve Bank of Kansas City. [Downloadable!]
  3. Raffaella Giacomini & Halbert White, 2004. "Tests of Conditional Predictive Ability," University of California at San Diego, Economics Working Paper Series 2003-09, Department of Economics, UC San Diego. [Downloadable!]
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  4. 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. [Downloadable!]
  5. 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. [Downloadable!] (restricted)
  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. Todd E. Clark & Kenneth D. West, 2004. "Using out-of-sample mean squared prediction errors to test the Martingale difference hypothesis," Research Working Paper RWP 04-03, Federal Reserve Bank of Kansas City. [Downloadable!]
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  8. Cheung, Yin-Wong & Chinn, Menzie D. & Pascual, Antonio Garcia, 2005. "Empirical exchange rate models of the nineties: Are any fit to survive?," Journal of International Money and Finance, Elsevier, vol. 24(7), pages 1150-1175, November. [Downloadable!] (restricted)
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  9. 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.
    Other versions:
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