This paper studies the dynamic relationship between exchange rate fluctuations and world commodity price movements. Taking into account parameter instability, we demonstrate surprisingly robust evidence that exchange rates predict world commodity price movements, both in-sample and out-of-sample. Because commodity prices are exogenous to the exchange rates we consider, we are able to overcome the identification problems that plague the existing empirical exchange rate literature. Because our finding that exchange rates predict future commodity prices can be given a true causal interpretation, it provides the most concrete support yet for the importance of selected macroeconomic fundamentals in determining exchange rates. As an important by-product of our analysis, we show that exchange rate-based forecasts may be a viable alternative for predicting future commodity price movements.
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Paper provided by Duke University, Department of Economics in its series Working Papers with number
08-03.
Length: 44 Pages Date of creation: 2008 Date of revision: Handle: RePEc:duk:dukeec:08-03
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Find related papers by JEL classification: C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation and Testing C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Other Model Applications F31 - International Economics - - International Finance - - - Foreign Exchange F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation
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