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Can panel data really improve the predictability of the monetary exchange rate model?

Author

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  • Joakim Westerlund

    (Department of Economics, Lund University, Lund, Sweden)

  • Syed A. Basher

    (Department of Economics, York University, Toronto, Ontario, Canada)

Abstract

A common explanation for the inability of the monetary model to beat the random walk in forecasting future exchange rates is that conventional time series tests may have low power, and that panel data should generate more powerful tests. This paper provides an extensive evaluation of this power argument to the use of panel data in the forecasting context. In particular, by using simulations it is shown that although pooling of the individual prediction tests can lead to substantial power gains, pooling only the parameters of the forecasting equation, as has been suggested in the previous literature, does not seem to generate more powerful tests. The simulation results are illustrated through an empirical application. Copyright © 2007 John Wiley & Sons, Ltd.

Suggested Citation

  • Joakim Westerlund & Syed A. Basher, 2007. "Can panel data really improve the predictability of the monetary exchange rate model?," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 26(5), pages 365-383.
  • Handle: RePEc:jof:jforec:v:26:y:2007:i:5:p:365-383
    DOI: 10.1002/for.1034
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    References listed on IDEAS

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    1. Kilian, Lutz, 1999. "Exchange Rates and Monetary Fundamentals: What Do We Learn from Long-Horizon Regressions?," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 14(5), pages 491-510, Sept.-Oct.
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    4. Anindya Banerjee & Massimiliano Marcellino & Chiara Osbat, 2004. "Some cautions on the use of panel methods for integrated series of macroeconomic data," Econometrics Journal, Royal Economic Society, vol. 7(2), pages 322-340, December.
    5. Rapach, David E. & Wohar, Mark E., 2002. "Testing the monetary model of exchange rate determination: new evidence from a century of data," Journal of International Economics, Elsevier, vol. 58(2), pages 359-385, December.
    6. Anindya Banerjee & Massimiliano Marcellino & Chiara Osbat, 2005. "Testing for PPP: Should we use panel methods?," Empirical Economics, Springer, vol. 30(1), pages 77-91, January.
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    9. 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.
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    11. Rapach, David E. & Wohar, Mark E., 2004. "Testing the monetary model of exchange rate determination: a closer look at panels," Journal of International Money and Finance, Elsevier, vol. 23(6), pages 867-895, October.
    12. Mark, Nelson C. & Sul, Donggyu, 2001. "Nominal exchange rates and monetary fundamentals: Evidence from a small post-Bretton woods panel," Journal of International Economics, Elsevier, vol. 53(1), pages 29-52, February.
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    16. Papell, David H & Theodoridis, Hristos, 2001. "The Choice of Numeraire Currency in Panel Tests of Purchasing Power Parity," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(3), pages 790-803, August.
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    Cited by:

    1. Galimberti, Jaqueson K. & Moura, Marcelo L., 2013. "Taylor rules and exchange rate predictability in emerging economies," Journal of International Money and Finance, Elsevier, vol. 32(C), pages 1008-1031.
    2. Narayan, Seema & Smyth, Russell, 2015. "The financial econometrics of price discovery and predictability," International Review of Financial Analysis, Elsevier, vol. 42(C), pages 380-393.
    3. Baltagi, Badi H., 2013. "Panel Data Forecasting," Handbook of Economic Forecasting, Elsevier.
    4. Kenneth S. Rogoff & Vania Stavrakeva, 2008. "The Continuing Puzzle of Short Horizon Exchange Rate Forecasting," NBER Working Papers 14071, National Bureau of Economic Research, Inc.

    More about this item

    JEL classification:

    • F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation: Models and Applications
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models

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