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The unbeatable random walk in exchange rate forecasting: Reality or myth?

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  • Moosa, Imad
  • Burns, Kelly

Abstract

It is demonstrated that the conventional monetary model of exchange rates can (irrespective of the specification, estimation method or the forecasting horizon) outperform the random walk in out-of-sample forecasting if forecasting power is measured by direction accuracy and profitability. Claims of outperforming the random walk in terms of the root mean square error are false because they are typically based on the introduction of dynamics, hence a random walk component, commonly without testing for the statistical significance of the difference between root mean square errors. And even if proper hypothesis testing reveals that a dynamic model outperforms the random walk, this amounts to beating the random walk by a random walk with the help of some explanatory variables. The failure of conventional macroeconomic models to outperform the random walk in terms of the root mean square error should be expected rather than considered to be a puzzle.

Suggested Citation

  • Moosa, Imad & Burns, Kelly, 2014. "The unbeatable random walk in exchange rate forecasting: Reality or myth?," Journal of Macroeconomics, Elsevier, vol. 40(C), pages 69-81.
  • Handle: RePEc:eee:jmacro:v:40:y:2014:i:c:p:69-81
    DOI: 10.1016/j.jmacro.2014.03.003
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    7. Afees A. Salisu & Wasiu Adekunle & Zachariah Emmanuel & Wasiu A. Alimi, 2018. "Predicting exchange rate with commodity prices: The role of structural breaks and asymmetries," Working Papers 055, Centre for Econometric and Allied Research, University of Ibadan.
    8. Salisu, Afees A. & Ogbonna, Ahamuefula E., 2019. "Another look at the energy-growth nexus: New insights from MIDAS regressions," Energy, Elsevier, vol. 174(C), pages 69-84.
    9. Dimitris P. Louzis, 2014. "Macroeconomic and credit forecasts in a small economy during crisis: A large Bayesian VAR approach," Working Papers 184, Bank of Greece.
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    More about this item

    Keywords

    Forecasting; Random walk; Exchange rate models; Direction accuracy; Monetary model;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

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