IDEAS home Printed from https://ideas.repec.org/a/gam/jmathe/v10y2022i2p228-d722904.html
   My bibliography  Save this article

A Simple Out-of-Sample Test of Predictability against the Random Walk Benchmark

Author

Listed:
  • Pablo Pincheira

    (School of Business, Universidad Adolfo Ibáñez, Peñalolén 8380629, Chile)

  • Nicolas Hardy

    (Facultad de Economía y Empresa, Universidad Diego Portales, Huechuraba 8370179, Chile)

  • Andrea Bentancor

    (Facultad de Economía y Negocios, Universidad de Talca, Talca 3460000, Chile)

Abstract

We show that a straightforward modification of a trading-based test for predictability displays interesting advantages over the Excess Profitability (EP) test proposed by Anatolyev and Gerco when testing the Driftless Random Walk Hypothesis. Our statistic is called the Straightforward Excess Profitability (SEP) test, and it avoids the calculation of a term that under the null of no predictability should be zero but in practice may be sizable. In addition, our test does not require the strong assumption of independence used to derive the EP test. We claim that dependence is the rule and not the exception. We show via Monte Carlo simulations that the SEP test outperforms the EP test in terms of size and power. Finally, we illustrate the use of our test in an empirical application within the context of the commodity-currencies literature.

Suggested Citation

  • Pablo Pincheira & Nicolas Hardy & Andrea Bentancor, 2022. "A Simple Out-of-Sample Test of Predictability against the Random Walk Benchmark," Mathematics, MDPI, vol. 10(2), pages 1-20, January.
    • Handle: RePEc:gam:jmathe:v:10:y:2022:i:2:p:228-:d:722904
    as

    Download full text from publisher

    File URL: https://www.mdpi.com/2227-7390/10/2/228/pdf
    Download Restriction: no
    File URL: https://www.mdpi.com/2227-7390/10/2/228/
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Barbara Rossi, 2013. "Exchange Rate Predictability," Journal of Economic Literature, American Economic Association, vol. 51(4), pages 1063-1119, December.
    2. Yu-Chin Chen & Kenneth S. Rogoff & Barbara Rossi, 2010. "Can Exchange Rates Forecast Commodity Prices?," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 125(3), pages 1145-1194.
    3. Pincheira, Pablo & Hardy, Nicolas, 2021. "The Mean Squared Prediction Error Paradox," MPRA Paper 107403, University Library of Munich, Germany.
    4. Clark, Todd E. & West, Kenneth D., 2006. "Using out-of-sample mean squared prediction errors to test the martingale difference hypothesis," Journal of Econometrics, Elsevier, vol. 135(1-2), pages 155-186.
    5. Pincheira Brown, Pablo & Hardy, Nicolás, 2019. "Forecasting base metal prices with the Chilean exchange rate," Resources Policy, Elsevier, vol. 62(C), pages 256-281.
    6. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Guo, Honggang & Wang, Jianzhou & Li, Zhiwu & Lu, Haiyan & Zhang, Linyue, 2022. "A non-ferrous metal price ensemble prediction system based on innovative combined kernel extreme learning machine and chaos theory," Resources Policy, Elsevier, vol. 79(C).
    2. Nicolás Magner & Nicolás Hardy, 2022. "Cryptocurrency Forecasting: More Evidence of the Meese-Rogoff Puzzle," Mathematics, MDPI, vol. 10(13), pages 1-27, July.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Nicolás Magner & Nicolás Hardy, 2022. "Cryptocurrency Forecasting: More Evidence of the Meese-Rogoff Puzzle," Mathematics, MDPI, vol. 10(13), pages 1-27, July.
    2. Pincheira-Brown, Pablo & Neumann, Federico, 2020. "Can we beat the Random Walk? The case of survey-based exchange rate forecasts in Chile," Finance Research Letters, Elsevier, vol. 37(C).
    3. Joseph P. Byrne & Dimitris Korobilis & Pinho J. Ribeiro, 2018. "On The Sources Of Uncertainty In Exchange Rate Predictability," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 59(1), pages 329-357, February.
    4. Joseph Agyapong, 2021. "Application of Taylor Rule Fundamentals in Forecasting Exchange Rates," Economies, MDPI, vol. 9(2), pages 1-27, June.
    5. Byrne, Joseph P. & Korobilis, Dimitris & Ribeiro, Pinho J., 2016. "Exchange rate predictability in a changing world," Journal of International Money and Finance, Elsevier, vol. 62(C), pages 1-24.
    6. Rossi, José Luiz Júnior, 2013. "Liquidity and Exchange Rates," Insper Working Papers wpe_325, Insper Working Paper, Insper Instituto de Ensino e Pesquisa.
    7. Domenico Ferraro & Kenneth S. Rogoff & Barbara Rossi, 2011. "Can oil prices forecast exchange rates?," Working Papers 11-34, Federal Reserve Bank of Philadelphia.
    8. Pincheira Brown, Pablo & Hardy, Nicolás, 2019. "Forecasting base metal prices with the Chilean exchange rate," Resources Policy, Elsevier, vol. 62(C), pages 256-281.
    9. Feng, Wenjun & Zhang, Zhengjun, 2023. "Currency exchange rate predictability: The new power of Bitcoin prices," Journal of International Money and Finance, Elsevier, vol. 132(C).
    10. Pablo Pincheira & Nicolás Hardy & Felipe Muñoz, 2021. "“Go Wild for a While!”: A New Test for Forecast Evaluation in Nested Models," Mathematics, MDPI, vol. 9(18), pages 1-28, September.
    11. Rossi, José Luiz Júnior, 2014. "The Usefulness of Financial Variables in Predicting Exchange Rate Movements," Insper Working Papers wpe_332, Insper Working Paper, Insper Instituto de Ensino e Pesquisa.
    12. Pincheira, Pablo & Hardy, Nicolas, 2021. "The Mean Squared Prediction Error Paradox," MPRA Paper 107403, University Library of Munich, Germany.
    13. Ismailov, Adilzhan & Rossi, Barbara, 2018. "Uncertainty and deviations from uncovered interest rate parity," Journal of International Money and Finance, Elsevier, vol. 88(C), pages 242-259.
    14. Pincheira-Brown, Pablo & Bentancor, Andrea & Hardy, Nicolás & Jarsun, Nabil, 2022. "Forecasting fuel prices with the Chilean exchange rate: Going beyond the commodity currency hypothesis," Energy Economics, Elsevier, vol. 106(C).
    15. Ferraro, Domenico & Rogoff, Kenneth & Rossi, Barbara, 2015. "Can oil prices forecast exchange rates? An empirical analysis of the relationship between commodity prices and exchange rates," Journal of International Money and Finance, Elsevier, vol. 54(C), pages 116-141.
    16. Byrne, Joseph P. & Korobilis, Dimitris & Ribeiro, Pinho J., 2014. "On the Sources of Uncertainty in Exchange Rate Predictability," 2007 Annual Meeting, July 29-August 1, 2007, Portland, Oregon TN 2015-24, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
    17. Pincheira, Pablo & Hardy, Nicolas, 2020. "The Mean Squared Prediction Error Paradox: A summary," MPRA Paper 105020, University Library of Munich, Germany.
    18. Beckmann, Joscha & Czudaj, Robert L. & Arora, Vipin, 2020. "The relationship between oil prices and exchange rates: Revisiting theory and evidence," Energy Economics, Elsevier, vol. 88(C).
    19. Philippe Bacchetta & Eric van Wincoop & Toni Beutler, 2010. "Can Parameter Instability Explain the Meese-Rogoff Puzzle?," NBER International Seminar on Macroeconomics, University of Chicago Press, vol. 6(1), pages 125-173.
    20. Ahmed, Shamim & Liu, Xiaoquan & Valente, Giorgio, 2016. "Can currency-based risk factors help forecast exchange rates?," International Journal of Forecasting, Elsevier, vol. 32(1), pages 75-97.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:gam:jmathe:v:10:y:2022:i:2:p:228-:d:722904. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: MDPI Indexing Manager (email available below). General contact details of provider: https://www.mdpi.com .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.