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Nonlinear Exchange Rate Predictability

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Author Info
Carlos Felipe Lopez Suarez
Jose Antonio Rodriguez Lopez () (Department of Economics, University of California-Irvine)

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Abstract

We study whether the nonlinear behavior of the real exchange rate can help us account for the lack of predictability of the nominal exchange rate. We construct a smooth nonlinear error-correction model that allows us to test the hypotheses of nonlinear predictability of the nominal exchange rate and nonlinear behavior on the real exchange rate in the context of a fully specified cointegrated system. Using a panel of 19 countries and three numeraires, we find strong evidence of nonlinear predictability of the nominal exchange rate and of nonlinear mean reversion of the real exchange rate. Out-of-sample Theil's U-statistics show a higher forecast precision of the nonlinear model than the one obtained with a random walk specification. The statistical significance of the out-of-sample results is higher for short-run horizons, specially for one-quarter-ahead forecasts.

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Publisher Info
Paper provided by University of California-Irvine, Department of Economics in its series Working Papers with number 080911.

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Length: 30 pages
Date of creation: Dec 2008
Date of revision:
Handle: RePEc:irv:wpaper:080911

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Postal: Irvine, CA 92697-3125
Phone: (949) 824-5788
Web page: http://www.econ.uci.edu/
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Related research
Keywords: Exchange rates; Predictability; Nonlinearities; Purchasing power parity;

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Find related papers by JEL classification:
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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