Forecasting the Spot Exchange Rate with the Term Structure of Forward Premia: Multivariate Threshold Cointegration
AbstractIn this paper we develop a multivariate threshold vector error correction model of spot and forward exchange rates that allows for different forms of equilibrium reversion in each of the cointegrating residual series. By introducing the notion of an indicator matrix to differentiate between the various regimes in the set of nonlinear processes we provide a convenient framework for estimation by OLS. Empirically, out-of sample forecasting exercises demonstrate its superiority over a linear VECM, while being unable to out-predict a (driftless) random walk model. As such we provide empirical evidence against the findings of Clarida and Taylor (1997).
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4958.
Date of creation: Mar 2005
Date of revision:
Contact details of provider:
Postal: Centre for Economic Policy Research, 77 Bastwick Street, London EC1V 3PZ
Phone: 44 - 20 - 7183 8801
Fax: 44 - 20 - 7183 8820
Find related papers by JEL classification:
- C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
- C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
- F31 - International Economics - - International Finance - - - Foreign Exchange
This paper has been announced in the following NEP Reports:
- NEP-ALL-2005-06-14 (All new papers)
- NEP-ECM-2005-06-14 (Econometrics)
- NEP-ETS-2005-06-14 (Econometric Time Series)
- NEP-FMK-2005-06-14 (Financial Markets)
- NEP-IFN-2005-06-14 (International Finance)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- George Kapetanios & Yongcheol Shin, 2004.
"Unit Root Tests in Three-Regime SETAR Models,"
ESE Discussion Papers
104, Edinburgh School of Economics, University of Edinburgh.
- repec:cup:macdyn:v:5:y:2001:i:4:p:533-76 is not listed on IDEAS
- Hansen, Bruce E, 1996.
"Inference When a Nuisance Parameter Is Not Identified under the Null Hypothesis,"
Econometric Society, vol. 64(2), pages 413-30, March.
- Tom Doan, . "RATS programs to replicate Hansen's threshold estimation and testing results," Statistical Software Components RTZ00091, Boston College Department of Economics.
- Hansen, B.E., 1991. "Inference when a Nuisance Parameter is Not Identified Under the Null Hypothesis," RCER Working Papers 296, University of Rochester - Center for Economic Research (RCER).
- Tom Doan, . "TAR: RATS procedure to estimate a threshold autoregression, tests for threshold effect," Statistical Software Components RTS00209, Boston College Department of Economics.
- Maria-Teresa Perez & Ana-Maria Fuertes & Jerry Coakley, 2001.
"Numerical Issues in Threshold Autoregressive Modelling of Time Series,"
wp01-09, Warwick Business School, Finance Group.
- Coakley, Jerry & Fuertes, Ana-Marı́a & Pérez, Marı́a-Teresa, 2003. "Numerical issues in threshold autoregressive modeling of time series," Journal of Economic Dynamics and Control, Elsevier, vol. 27(11), pages 2219-2242.
- Coakley, Jerry & Fuertes, Ana-Maria & Perez, Maria-Teresa, 2003. "Numerical issues in threshold autoregressive modeling of time series," Journal of Economic Dynamics and Control, Elsevier, vol. 27(11-12), pages 2219-2242, September.
- Wolff, Christian C P, 1987. "Time-Varying Parameters and the Out-of-Sample Forecasting Performance of Structural Exchange Rate Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 5(1), pages 87-97, January.
- repec:ner:maastr:urn:nbn:nl:ui:27-10053 is not listed on IDEAS
- Seo, Byeongseon, 2003. "Nonlinear mean reversion in the term structure of interest rates," Journal of Economic Dynamics and Control, Elsevier, vol. 27(11-12), pages 2243-2265, September.
- Donald W.K. Andrews & Werner Ploberger, 1992.
"Optimal Tests When a Nuisance Parameter Is Present Only Under the Alternative,"
Cowles Foundation Discussion Papers
1015, Cowles Foundation for Research in Economics, Yale University.
- Andrews, Donald W K & Ploberger, Werner, 1994. "Optimal Tests When a Nuisance Parameter Is Present Only under the Alternative," Econometrica, Econometric Society, vol. 62(6), pages 1383-1414, November.
- Richard H. Clarida & Mark P. Taylor, 1997. "The Term Structure Of Forward Exchange Premiums And The Forecastability Of Spot Exchange Rates: Correcting The Errors," The Review of Economics and Statistics, MIT Press, vol. 79(3), pages 353-361, August.
- Hansen,B.E., 1999.
"Testing for linearity,"
7, Wisconsin Madison - Social Systems.
- Lo, Ming Chien & Zivot, Eric, 2001. "Threshold Cointegration And Nonlinear Adjustment To The Law Of One Price," Macroeconomic Dynamics, Cambridge University Press, vol. 5(04), pages 533-576, September.
- Hylleberg, Svend & Mizon, Grayham E, 1989. "Cointegration and Error Correction Mechanisms," Economic Journal, Royal Economic Society, vol. 99(395), pages 113-25, Supplemen.
- repec:ner:maastr:urn:nbn:nl:ui:27-13899 is not listed on IDEAS
- Nathan S. Balke & Thomas B. Fomby, 1992.
9209, Federal Reserve Bank of Dallas.
- Hall, Anthony D & Anderson, Heather M & Granger, Clive W J, 1992. "A Cointegration Analysis of Treasury Bill Yields," The Review of Economics and Statistics, MIT Press, vol. 74(1), pages 116-26, February.
- Wolff, Christian C, 1987.
"Exchange Rates, Innovations and Forecasting,"
CEPR Discussion Papers
188, C.E.P.R. Discussion Papers.
- repec:dgr:eureir:1999101 is not listed on IDEAS
- Hansen, Bruce E. & Seo, Byeongseon, 2002.
"Testing for two-regime threshold cointegration in vector error-correction models,"
Journal of Econometrics,
Elsevier, vol. 110(2), pages 293-318, October.
- Tom Doan, . "RATS programs to replicate Hansen/Seo paper on threshold cointegration," Statistical Software Components RTZ00092, Boston College Department of Economics.
- Seo, Byeongseon, 2003. "Nonlinear mean reversion in the term structure of interest rates," Journal of Economic Dynamics and Control, Elsevier, vol. 27(11), pages 2243-2265.
- Pippenger, Michael K & Goering, Gregory E, 1993. "A Note on the Empirical Power of Unit Root Tests under Threshold Processes," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 55(4), pages 473-81, November.
- Kapetanios, G., 1999. "Model Selection in Threshold Models," Cambridge Working Papers in Economics 9906, Faculty of Economics, University of Cambridge.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().
If references are entirely missing, you can add them using this form.