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Balance of payments flows and exchange rate prediction in Japan

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  • Müller-Plantenberg, Nikolas

    ()
    (Departamento de Análisis Económico (Teoría e Historia Económica). Universidad Autónoma de Madrid.)

Abstract

Monetary models of exchange rates tend to focus on inflation differentials to explain exchange rate movements. This paper assesses the ability of currency flows to predict exchange rate changes. The focus is on Japan. Currency flows are assumed to depend on the level of the current account and on the international investment position, where the latter is used as a proxy for international debt repayments. A state space model is used to predict simultaneously the exchange rate and its determinants. Using rolling regressions and out-of-sample predictions, it is shown that a model featuring currency flows can predict the direction of exchange rate movements better than a random walk (with or without drift). However, as happens with standard macroeconomic models, the model is not able to outperform a random walk in terms of the mean square prediction error criterion.

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Bibliographic Info

Paper provided by Universidad Autónoma de Madrid (Spain), Department of Economic Analysis (Economic Theory and Economic History) in its series Working Papers in Economic Theory with number 2012/09.

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Length: 22 pages
Date of creation: Mar 2012
Date of revision:
Handle: RePEc:uam:wpaper:201209

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Related research

Keywords: balance of payments flows; international investment position; exchange rate prediction; out-of-sample prediction; random walk.;

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  1. Menzie D. Chinn & Ron Alquist, 2006. "Conventional and Unconventional Approaches to Exchange Rate Modeling and Assessment," NBER Working Papers 12481, National Bureau of Economic Research, Inc.
  2. Commandeur, Jacques J.F. & Koopman, Siem Jan, 2007. "An Introduction to State Space Time Series Analysis," OUP Catalogue, Oxford University Press, number 9780199228874, September.
  3. Paolo Vitale, 2007. "A Guided Tour Of The Market Microstructure Approach To Exchange Rate Determination," Journal of Economic Surveys, Wiley Blackwell, vol. 21(5), pages 903-934, December.
  4. Yin-Wong Cheung & Antonio Garcia Pascual & Menzie David Chinn, 2004. "Empirical Exchange Rate Models of the Nineties," IMF Working Papers 04/73, International Monetary Fund.
  5. Nikolas Müller-Plantenberg, 2003. "Japan's Imbalance of Payments," CESifo Working Paper Series 1089, CESifo Group Munich.
  6. Müller-Plantenberg, Nikolas A., 2010. "Balance of payments accounting and exchange rate dynamics," International Review of Economics & Finance, Elsevier, vol. 19(1), pages 46-63, January.
  7. Goffe, William L. & Ferrier, Gary D. & Rogers, John, 1994. "Global optimization of statistical functions with simulated annealing," Journal of Econometrics, Elsevier, vol. 60(1-2), pages 65-99.
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