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A Consumption-Based Approach to Exchange Rate Predictability

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  • Jair N. Ojeda-Joya

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Abstract

This paper provides evidence of short-run predictability for the real exchange rate by performing out-of-sample tests of a forecasting equation which is derived from a consumption-based asset pricing model. In this model, the real exchange rate is predictable as a result of the implications of preferences with habit persistence on the pricing of international assets. The implied predictors are: domestic, US and world consumption growth. Empirical exercises show evidence of short-term predictability on the bilateral rates of 15 out of 17 countries vis-à-vis the US over the post Bretton-Woods float. A GMM estimation of the parameters of the model also finds evidence of the presence of habits in consumers’ preferences.

Suggested Citation

  • Jair N. Ojeda-Joya, 2014. "A Consumption-Based Approach to Exchange Rate Predictability," BORRADORES DE ECONOMIA 012339, BANCO DE LA REPÚBLICA.
  • Handle: RePEc:col:000094:012339
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    References listed on IDEAS

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    More about this item

    Keywords

    Exchange rates; out-of-sample; predictability; asset pricing; habits;

    JEL classification:

    • C5 - Mathematical and Quantitative Methods - - Econometric Modeling
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation: Models and Applications
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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