Real exchange rate forecasting: a calibrated half-life PPP model can beat the random walk
AbstractThis paper brings two new insights into the Purchasing Power Parity (PPP) debate. First, even if PPP is thought to hold only in the long run, we show that a half-life PPP model outperforms the random walk in real exchange rate forecasting, also at short-term horizons. Second, we show that this result holds as long as the speed of adjustment to the sample mean is imposed and not estimated. The reason is that the estimation error of the pace of convergence distorts the results in favor of the random walk model, even if the PPP holds in the long-run.
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Bibliographic InfoPaper provided by National Bank of Poland, Economic Institute in its series National Bank of Poland Working Papers with number 123.
Date of creation: 2012
Date of revision:
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Exchange rate forecasting; purchasing power parity; half-life;
Other versions of this item:
- Ca' Zorzi, Michele & Muck, Jakub & Rubaszek, Michał, 2013. "Real exchange rate forecasting: a calibrated half-life PPP model can beat the random walk," Working Paper Series 1576, European Central Bank.
- C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
- F31 - International Economics - - International Finance - - - Foreign Exchange
- F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-10-27 (All new papers)
- NEP-FOR-2012-10-27 (Forecasting)
- NEP-MON-2012-10-27 (Monetary Economics)
- NEP-OPM-2012-10-27 (Open Economy Macroeconomics)
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