The out-of-sample forecasting performance of exchange rate models when coefficients are allowed to change
This study examines the out-of-sample forecasting performance of models of exchange rate determination without imposing the restriction that coefficients are fixed over time. Both fixed and variable coefficient versions of conventional structural models are considered, with and without a lagged dependent variable. While our results on fixed coefficient models support most of the Meese and Rogoff conclusions, we find that when coefficients are allowed to change, an important subset of conventional models of the dollar-pound, the dollar-deutsche mark, and the dollar-yen exchange rates can outperform forecasts of a random walk model. The structural models considered are the flexible-price (Frenkel-Bilson) and sticky-price (Dornbusch-Frankel) monetary models, and a sticky-price model which includes the current account (Hooper-Morton). We also find that the variable coefficient version of the Dornbusch-Frankel model with a lagged dependent variable generally predicts better than the other models considered including the random walk model.
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- Hooper, Peter & Morton, John, 1982. "Fluctuations in the dollar: A model of nominal and real exchange rate determination," Journal of International Money and Finance, Elsevier, vol. 1(1), pages 39-56, January.
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- Richard Meese & Kenneth Rogoff, 1983. "The Out-of-Sample Failure of Empirical Exchange Rate Models: Sampling Error or Misspecification?," NBER Chapters, in: Exchange Rates and International Macroeconomics, pages 67-112 National Bureau of Economic Research, Inc.
- Richard Meese & Kenneth Rogoff & Jacob Frenkel, "undated". "The Out-of-Sample Failure of Empirical Exchange Rate Models: Sampling Error or Misspecification?," Working Paper 32044, Harvard University OpenScholar.
- P. A. V. B. Swamy & Garry J. Schinasi, 1987. "Should fixed coefficients be reestimated every period," Special Studies Papers 213, Board of Governors of the Federal Reserve System (U.S.).
- Makin, John H & Sauer, Raymond D, 1986. "Exchange Rate Determination with Changes in the Policy Regime: The Yen-Dollar Rate," The Review of Economics and Statistics, MIT Press, vol. 68(1), pages 164-169, February.
- Hakkio, Craig, 1986. "Does the exchange rate follow a random walk? A Monte Carlo study of four tests for a random walk," Journal of International Money and Finance, Elsevier, vol. 5(2), pages 221-229, June.
- Wolff, Christian C P, 1987. "Time-Varying Parameters and the Out-of-Sample Forecasting Performance of Structural Exchange Rate Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 5(1), pages 87-97, January.
- Frankel, Jeffrey A, 1979. "On the Mark: A Theory of Floating Exchange Rates Based on Real Interest Differentials," American Economic Review, American Economic Association, vol. 69(4), pages 610-622, September.
- Finn, Mary G., 1986. "Forecasting the exchange rate: A monetary or random walk phenomenon?," Journal of International Money and Finance, Elsevier, vol. 5(2), pages 181-193, June.
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