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Forecasting the Real US/DEM Exchange Rate: TAR vs. AR

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Author Info

  • Kuo, Biing-Shen

    (Bank of Finland Research)

  • Mikkola, Anne

    (Bank of Finland Research)

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    Abstract

    The out-of-sample forecasting performances of two univariate time series presentations for the USD/DEM real exchange rate are compared using quarterly data for the period 1957Q1-1998Q4. The linear AR process is frequently fitted to real exchange rate series because it is sufficient for capturing the reported slow mean reversion in real exchange rates and it has some predictive ability for the long run. A simple nonlinear alternative, the threshold autoregressive (TAR) model, allows for the possibility that there is a band of slow or no convergence around the purchasing power parity level in the real exchange rate, due to transportation costs or other market frictions that create barriers to arbitrage. The TAR model is theoretically and empirically appealing, and it has been fitted to real exchange rates in many recent papers. However, the ultimate test of its usefulness is its out-of-sample forecasting accuracy. We compare the TAR model to its simple linear AR alternative in terms of out-of-sample forecast accuracy. Preliminary results using the RMSE criterion indicate that TAR forecasts are more sensitive to the estimation period and that they involve considerably more uncertainty at long horizons, as compared with the simple AR model.

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    File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/0013.pdf
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    Bibliographic Info

    Paper provided by Bank of Finland in its series Research Discussion Papers with number 13/2000.

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    Length: 21 pages
    Date of creation: 03 Oct 2000
    Date of revision:
    Handle: RePEc:hhs:bofrdp:2000_013

    Contact details of provider:
    Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
    Web page: http://www.suomenpankki.fi/en/
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    Related research

    Keywords: real exchange rate; TAR model; forecast accuracy;

    References

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    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.:
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    1. Clements, Michael P. & Smith, Jeremy, 1997. "The performance of alternative forecasting methods for SETAR models," International Journal of Forecasting, Elsevier, vol. 13(4), pages 463-475, December.
    2. Michael, Panos & Nobay, A Robert & Peel, David A, 1997. "Transactions Costs and Nonlinear Adjustment in Real Exchange Rates: An Empirical Investigation," Journal of Political Economy, University of Chicago Press, vol. 105(4), pages 862-79, August.
    3. Hansen, Bruce E, 1996. "Inference When a Nuisance Parameter Is Not Identified under the Null Hypothesis," Econometrica, Econometric Society, vol. 64(2), pages 413-30, March.
    4. Engel, C., 1996. "Long-Run PPP May Not Hold After All," Discussion Papers in Economics at the University of Washington 96-05, Department of Economics at the University of Washington.
    5. Kuo, B.-S. & Mikkola, A., 1999. "How Sure are we About PPP Panel Evidence with the Null of Stationary Real Exchange Rates," University of Helsinki, Department of Economics 451, Department of Economics.
    6. Lothian, James R., 1998. "Some new stylized facts of floating exchange rates," Journal of International Money and Finance, Elsevier, vol. 17(1), pages 29-39, February.
    7. Diebold, Francis X. & Nason, James A., 1990. "Nonparametric exchange rate prediction?," Journal of International Economics, Elsevier, vol. 28(3-4), pages 315-332, May.
    8. Lothian, James R & Taylor, Mark P, 1996. "Real Exchange Rate Behavior: The Recent Float from the Perspective of the Past Two Centuries," Journal of Political Economy, University of Chicago Press, vol. 104(3), pages 488-509, June.
    9. Kuo, Biing-Shen & Mikkola, Anne, 1999. "Re-examining long-run purchasing power parity," Journal of International Money and Finance, Elsevier, vol. 18(2), pages 251-266, February.
    10. Kuo, Biing-Shen & Mikkola, Anne, 1999. "How Sure Are We About PPP? Panel Evidence with the Null of Stationary Real Exchange Rates," CEPR Discussion Papers 2120, C.E.P.R. Discussion Papers.
    11. Clements, Michael P & Smith, Jeremy, 1999. "A Monte Carlo Study of the Forecasting Performance of Empirical SETAR Models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 14(2), pages 123-41, March-Apr.
    12. Bruce E. Hansen, 2000. "Sample Splitting and Threshold Estimation," Econometrica, Econometric Society, vol. 68(3), pages 575-604, May.
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