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).
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Date of creation: Mar 2005
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- 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)
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