Non Linear Error Correction in Spot and Forward Exchange Rates
AbstractRecent research has increasingly suggested that exchange rates may be characterised by non-linear behaviour which results from the existence of market frictions. This paper examines whether such non-linear behaviour is evident, not in rates themselves, but in the adjustment of rates back to some fundamental equilibrium. Thus, we examine a series of six spot and forward exchange rates to see whether a non-linear error-correction model, which exhibits asymmetric adjustment back to equilibrium either in terms of the size of the deviation from equilibrium or the sign of the deviation outperforms either a random walk model for rates or a linear error-correction model. Our in-sample results suggest that the non-linear models outperform both the linear models, with evidence of significant sign and size threshold effects. Out-of-sample forecasts lend further support for the non-linear models.
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Bibliographic InfoPaper provided by Centre for Research into Industry, Enterprise, Finance and the Firm in its series CRIEFF Discussion Papers with number 0103.
Date of creation: Feb 2001
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Non-Linear Error-Correction; Forecasting; Spot and Forward Exchange Rates;
Other versions of this item:
- David McMillan & Angela Black, 2001. "Nonlinear error correction in spot and forward exchange rates," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 137(4), pages 737-750, December.
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
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