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Nonlinear Exchange Rate Models

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  • Lucio Sarno

Abstract

This paper provides a selective overview of nonlinear exchange rate models recently proposed in the literature and assesses their contribution to understanding exchange rate behavior. Two key questions are examined. The first question is whether nonlinear autoregressive models of real exchange rates help resolve the "purchasing power parity (PPP) puzzles." The second question is whether recently developed nonlinear, regime-switching vector equilibrium correction models of the nominal exchange rate can beat a random walk model, the standard benchmark in the exchange rate literature, in terms of out-of-sample forecasting performance. Finally, issues related to the adequateness of standard methods of evaluation of (linear and nonlinear) exchange rate models are discussed with reference to different forecast accuracy criteria.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 03/111.

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Length: 39
Date of creation: 01 May 2003
Date of revision:
Handle: RePEc:imf:imfwpa:03/111

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Keywords: Purchasing power parity; Exchange rates; Forecasting models; exchange rate; forecasting; real exchange rate; random walk; real exchange rates; probability; statistics; nominal exchange rate; nonlinear models; bootstrap; exchange rate forecasting; probability density; exchange rate behavior; cointegration; statistic; equation; forward exchange; statistical significance; foreign exchange; exchange rate movements; dollar exchange rates; econometrics; time series; exchange rate adjustment; survey; nonlinearity; equations; consistent estimate; spot exchange rates; nominal exchange rates; linear model; significance levels; exchange rate data; spot exchange rate; forward exchange rate; covariance; exchange rate economics; real exchange rate behavior; predictability; samples; forward exchange rates; mean square; linear models; exchange rate literature; maximum likelihood estimation; integral; predictions; confidence interval; nonlinear model; dollar exchange rate; exchange rate dynamics; exchange rate determination; empirical exercise; exchange rate system; linear time; normal distribution; vector autoregression; estimation technique; floating exchange rate regime; real exchange rate series; future spot exchange rates; empirical model; statistical distribution; exchange premiums; prediction; sample size; surveys; random numbers; adjustment parameter; real exchange rate dynamics; foreign exchange market; calibration; extrapolation; fitted value; parameter estimation; real exchange rate movements; logarithm; confidence intervals; exchange rate changes; law of large numbers; probability density function; exchange rate regime; random walk process; statistical tests; multivariate analysis; monte carlo methods; monte carlo simulations; floating exchange rates; finite variance; absolute error; dynamic models; mathematical statistics; market exchange rate; asymptotic distribution; stationary process; logarithms; probability function; normal distributions; tests of significance; floating exchange rate; general equilibrium models;

References

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Citations

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Cited by:
  1. Ales Bulir, 2003. "Some Exchange Rates Are More Stable than Others: Short-Run Evidence from Transition Countries," Working Papers 2003/05, Czech National Bank, Research Department.
  2. Erik Alencar de Figueiredo & André de Mattos Marques, 2013. "Testing absolute PPP hypothesis for twenty countries through the skeleton from a SETAR model- some new evidence," Série Textos para Discussão (Working Papers) 16, Programa de Pós-Graduação em Economia - PPGE, Universidade Federal da Paraíba.
  3. Miller, J. Isaac, 2011. "Testing the bounds: Empirical behavior of target zone fundamentals," Economic Modelling, Elsevier, vol. 28(4), pages 1782-1792, July.
  4. Junttila, Juha & Korhonen, Marko, 2011. "Nonlinearity and time-variation in the monetary model of exchange rates," Journal of Macroeconomics, Elsevier, vol. 33(2), pages 288-302, June.
  5. Ming Chien Lo & James Morley, 2013. "Bayesian Analysis of Nonlinear Exchange Rate Dynamics and the Purchasing Power Parity Persistence Puzzle," Discussion Papers 2013-05, School of Economics, The University of New South Wales.
  6. John W. Galbraith & Greg Tkacz, 2007. "How Far Can Forecasting Models Forecast? Forecast Content Horizons for Some Important Macroeconomic Variables," Working Papers 07-1, Bank of Canada.
  7. Ales Bulir, 2004. "Liberalized Markets Have More Stable Exchange Rates," IMF Working Papers 04/35, International Monetary Fund.
  8. Pau Rabanal & Juan F. Rubio-Ramirez, 2012. "Can International Macroeconomic Models Explain Low-Frequency Movements of Real Exchange Rates?," IMF Working Papers 12/13, International Monetary Fund.

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