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Forecasting and Combining Competing Models of Exchange Rate Determination

  • Carlo Altavilla
  • Paul De Grauwe

This paper investigates the out-of-sample forecast performance of a set of competing models of exchange rate determination. We compare standard linear models with models that characterize the relationship between exchange rate and its underlying fundamentals by nonlinear dynamics. Linear models tend to outperform at short forecast horizons especially when deviations from long-term equilibrium are small. In contrast, nonlinear models withmore elaborate mean-reverting components dominate at longer horizons especially whendeviations from long-term equilibrium are large. The results also suggest that combining different forecasting procedures generally produces more accurate forecasts than can be attained from a single model.

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File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2006/wp-cesifo-2006-06/cesifo1_wp1747.pdf
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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 1747.

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Date of creation: 2006
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Handle: RePEc:ces:ceswps:_1747
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  9. repec:dgr:uvatin:20010031 is not listed on IDEAS
  10. Fair, Ray C & Shiller, Robert J, 1990. "Comparing Information in Forecasts from Econometric Models," American Economic Review, American Economic Association, vol. 80(3), pages 375-89, June.
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  17. Carlo Altavilla & Paul De Grauwe, 2010. "Non-linearities in the relation between the exchange rate and its fundamentals," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 15(1), pages 1-21.
  18. Engel, Charles & Hamilton, James D, 1990. "Long Swings in the Dollar: Are They in the Data and Do Markets Know It?," American Economic Review, American Economic Association, vol. 80(4), pages 689-713, September.
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