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Forecasting Performance of Logistic STAR Exchange Rate Model: The Original and Reparameterised Versions

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  • Liew Khim Sen

    (Universiti Putra Malaysia)

  • Ahmad Zubaidi Baharumshah

    (Universiti Putra Malaysia)

Abstract

Exponential Smooth Transition Autoregressive (ESTAR) model is widely adopted in the exchange rate study as its symmetrical distribution matches that of the symmetrical exchange rate adjustment behaviour. In contrast, another specification of STAR model, namely the LSTAR (logistic STAR) model is discarded by most researchers in priori in their exchange rate modeling exercises due to its undesired property of being asymmetry. This study is the first of its kind in examining the validity of this hypothesis that the ESTAR exchange rate model is superior to LSTAR exchange rate model on the basis of forecasting accuracy. Based on the experience of the adjustment process of two nominal exchange rates, we find that the hypothesis is merely theoretical since we fail to provide consistent empirical evidence in favour of the null hypothesis. This warrants us that we need not be too pessimistic on the usage of LSTAR model in exchange rate study. In our effort to rekindle the usage of LSTAR model, we further reparameterized the original version into the so-called absolute version, which has symmetrical distribution properties, in accordance with the well-known symmetrical adjustment process of exchange rate. The resulting ALSTAR model has proven to be a more promising model in the sense that it has improved significantly from its original version as well as the ESTAR model, which has thus far been deemed the most appropriate nonlinear exchange rate model.

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Bibliographic Info

Paper provided by EconWPA in its series GE, Growth, Math methods with number 0308001.

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Date of creation: 03 Aug 2003
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Handle: RePEc:wpa:wuwpge:0308001

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Related research

Keywords: LSTAR; ESTAR; forecasting accuracy; nonlinear; exchange rate;

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References

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  1. Taylor, Mark P. & Sarno, Lucio, 1998. "The behavior of real exchange rates during the post-Bretton Woods period," Journal of International Economics, Elsevier, vol. 46(2), pages 281-312, December.
  2. Terasvirta, T & Anderson, H M, 1992. "Characterizing Nonlinearities in Business Cycles Using Smooth Transition Autoregressive Models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 7(S), pages S119-36, Suppl. De.
  3. Meese, Richard A & Rogoff, Kenneth, 1988. " Was It Real? The Exchange Rate-Interest Differential Relation over the Modern Floating-Rate Period," Journal of Finance, American Finance Association, vol. 43(4), pages 933-48, September.
  4. Álvaro Escribano & Oscar Jordá, 2001. "Testing nonlinearity: Decision rules for selecting between logistic and exponential STAR models," Spanish Economic Review, Springer, vol. 3(3), pages 193-209.
  5. Venus Khim-Sen Liew & Ahmad Zubaidi Baharumshahb & Evan Laub, 2004. "Nonlinear Adjustment towards Purchasing Power Parity in ASEAN Exchange Rates," The IUP Journal of Applied Economics, IUP Publications, vol. 0(6), pages 7-18, November.
  6. Taylor, Mark P. & Peel, David A., 2000. "Nonlinear adjustment, long-run equilibrium and exchange rate fundamentals," Journal of International Money and Finance, Elsevier, vol. 19(1), pages 33-53, February.
  7. Christopher F. Baum & Mustafa Caglayan & John Barkoulas, 1998. "Nonlinear Adjustment to Purchasing Power Parity in the post-Bretton Woods Era," Boston College Working Papers in Economics 404., Boston College Department of Economics, revised 16 Nov 1999.
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Cited by:
  1. Lin, Jeng-Bau & Liang, Chin-Chia & Yeh, Ming-Liang, 2011. "Examining nonlinear dynamics of exchange rates and forecasting performance based on the exchange rate parity of four Asian economies," Japan and the World Economy, Elsevier, vol. 23(2), pages 79-85, March.
  2. Derek Bond & Michael J. Harrison & Edward J. O'Brien, 2006. "Purchasing Power Parity: The Irish Experience Re-visited," Trinity Economics Papers tep200615, Trinity College Dublin, Department of Economics.
  3. McMillan, David G., 2009. "The confusing time-series behaviour of real exchange rates: Are asymmetries important?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 19(4), pages 692-711, October.

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