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Comparing Forecast Performance of Exchange Rate Models

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Author Info
Lillie Lam (Research Department, Hong Kong Monetary Authority)
Laurence Fung (Research Department, Hong Kong Monetary Authority)
Ip-wing Yu (Research Department, Hong Kong Monetary Authority)
Abstract

Exchange-rate movement is regularly monitored by central banks for macroeconomic-analysis and market-surveillance purposes. Notwithstanding the pioneering study of Meese and Rogoff (1983), which shows the superiority of the random-walk model in out-of-sample exchange-rate forecast, there is some evidence that exchange-rate movement may be predictable at longer time horizons. This study compares the forecast performance of the Purchasing Power Parity model, Uncovered Interest Rate Parity model, Sticky Price Monetary model, the model based on the Bayesian Model Averaging technique, and a combined forecast of all the above models with benchmarks given by the random-walk model and the historical average return. Empirical results suggest that the combined forecast outperforms the benchmarks and generally yields better results than relying on a single model.

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Publisher Info
Paper provided by Hong Kong Monetary Authority in its series Working Papers with number 0808.

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Length: 23 pages
Date of creation: Jun 2008
Date of revision:
Handle: RePEc:hkg:wpaper:0808

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Related research
Keywords: Bayesian Analysis; Model Evaluation and Selection; Forecasting and Other Model Application;

Find related papers by JEL classification:
C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Bayesian Analysis
C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation and Testing
C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Other Model Applications

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  1. Frankel, Jeffrey A, 1979. "On the Mark: A Theory of Floating Exchange Rates Based on Real Interest Differentials," American Economic Review, American Economic Association, vol. 69(4), pages 610-22, September. [Downloadable!] (restricted)
  2. Carmen Fernandez & Eduardo Ley & Mark Steel, 1999. "Model uncertainty in cross-country growth regressions," Econometrics 9903003, EconWPA, revised 06 Oct 2001. [Downloadable!]
    Other versions:
  3. K. J. Martijn Cremers, 2002. "Stock Return Predictability: A Bayesian Model Selection Perspective," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 15(4), pages 1223-1249.
  4. Min, Chung-ki & Zellner, Arnold, 1993. "Bayesian and non-Bayesian methods for combining models and forecasts with applications to forecasting international growth rates," Journal of Econometrics, Elsevier, vol. 56(1-2), pages 89-118, March. [Downloadable!] (restricted)
    Other versions:
  5. Jeffrey A. Frankel & Andrew K. Rose, 1994. "A Survey of Empirical Research on Nominal Exchange Rates," NBER Working Papers 4865, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  6. Alexius, Annika, 2001. "Uncovered Interest Parity Revisited," Review of International Economics, Blackwell Publishing, vol. 9(3), pages 505-17, August. [Downloadable!] (restricted)
  7. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December. [Downloadable!] (restricted)
  8. Meese, Richard A & Rose, Andrew K, 1991. "An Empirical Assessment of Non-linearities in Models of Exchange Rate Determination," Review of Economic Studies, Blackwell Publishing, vol. 58(3), pages 603-19, May. [Downloadable!] (restricted)
    Other versions:
  9. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February. [Downloadable!] (restricted)
  10. Yin-Wong Cheung & Menzie David Chinn & Antonio Garcia Pascual, 2004. "Empirical Exchange Rate Models of the Nineties: Are Any Fit to Survive?," IMF Working Papers 04/73, International Monetary Fund. [Downloadable!]
    Other versions:
  11. Chinn, Menzie D. & Meese, Richard A., 1995. "Banking on currency forecasts: How predictable is change in money?," Journal of International Economics, Elsevier, vol. 38(1-2), pages 161-178, February. [Downloadable!] (restricted)
  12. Guy Meredith & Menzie D. Chinn, 1998. "Long-Horizon Uncovered Interest Rate Parity," NBER Working Papers 6797, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  13. Mark, Nelson C, 1995. "Exchange Rates and Fundamentals: Evidence on Long-Horizon Predictability," American Economic Review, American Economic Association, vol. 85(1), pages 201-18, March.
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