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Understanding forecast failure of ESTAR models of real exchange rates

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Author Info
Buncic, Daniel
Abstract

The forecast performance of the empirical ESTAR model of Taylor, Peel and Sarno (2001) is examined for 4 bilateral real exchange rate series over an out-of-sample evaluation period of nearly 12 years. Point as well as density forecasts are constructed, considering forecast horizons of 1 to 22 steps head. The study finds that no forecast gains over a simple AR(1) specification exist at any of the forecast horizons that are considered, regardless of whether point or density forecasts are utilised in the evaluation. Non-parametric methods are used in conjunction with simulation techniques to learn about the models and their forecasts. It is shown graphically that the nonlinearity in the point forecasts of the ESTAR model decreases as the forecast horizon increases. The non-parametric methods show also that the multiple steps ahead forecast densities are normal looking with no signs of bi-modality, skewness or kurtosis. Overall, there seems little to be gained from using an ESTAR specification over a simple AR(1) model.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 16525.

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Date of creation: 03 Feb 2009
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Handle: RePEc:pra:mprapa:16525

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Related research
Keywords: Purchasing power parity; regime modelling; non-linear real exchange rate models; ESTAR; forecast evaluation; density forecasts; non-parametric methods.;

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Find related papers by JEL classification:
C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Other Model Applications
C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation and Testing
C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions
F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation
F31 - International Economics - - International Finance - - - Foreign Exchange

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  7. Rapach, David E. & Wohar, Mark E., 2006. "The out-of-sample forecasting performance of nonlinear models of real exchange rate behavior," International Journal of Forecasting, Elsevier, vol. 22(2), pages 341-361. [Downloadable!] (restricted)
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