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External Imbalances, Valuation Adjustments and Real Exchange Rate: Evidence of Predictability in an Emerging Economy

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  • Jorge Selaive
  • Pablo Pincheira B.

Abstract

We evaluate the ability of a measure of external imbalances that combines the trade and the financial channels to forecast the real effective exchange rate for Chile. By making use of a quarterly database of external assets and liabilities for the period 1983 to 2005, and employing a recently developed test of out-of-sample predictive ability, we show that this measure is able to predict the real exchange rate at horizons of up to 2 years. Out-of-sample evidence of predictability tends to get stronger as the size of the window used to estimate the parameters increases. This is probably because of the greater relative importance of the external balance in the dynamics of the exchange rate in the last few years, or because of the increasing precision of parameter estimates with the sample size. When we break down our measure of external imbalances into its three components: exports to imports ratio, exports to assets ratio and assets to liabilities ratio, we find that out-of-sample predictability is mainly driven by the last two ratios.

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Bibliographic Info

Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 460.

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Date of creation: Mar 2008
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Handle: RePEc:chb:bcchwp:460

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  1. Pierre-Olivier Gourinchas & Hélène Rey, 2005. "International financial adjustment," Proceedings, Federal Reserve Bank of San Francisco.
  2. Kenneth D. West & Whitney K. Newey, 1995. "Automatic Lag Selection in Covariance Matrix Estimation," NBER Technical Working Papers 0144, National Bureau of Economic Research, Inc.
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