IDEAS home Printed from
MyIDEAS: Login to save this paper or follow this series

Testing Long-horizon Predictive Ability with High Persistence, and the Meese-Rogoff Puzzle

  • Rossi, Barbara

A well-known puzzle in the international finance literature is that a random walk predicts exchange rates better than economic models (Meese and Rogoff, 1983a, b and 1988). This paper offers a potential explanation for this finding. When exchange rates and fundamentals are highly persistent, long-horizon forecasts of economic models are biased by the estimation error in the parameter that measures the persistence. When this bias outweighs the benefits from exploiting economic information, the random walk model will forecast better. This happens even if the economic model is the true data generating process. The reason is that a random walk model imposes a unit root, rather than estimates it. The paper thus proposes a test for equal predictive ability in the presence of highly persistent variables. When applied to the Meese-Rogoff exercise, this test shows that the poor forecasting ability of economic models DOES NOT imply that the models are NOT a good description of the data.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL:
File Function: main text
Download Restriction: no

Paper provided by Duke University, Department of Economics in its series Working Papers with number 02-10.

in new window

Date of creation: 2002
Date of revision:
Handle: RePEc:duk:dukeec:02-10
Contact details of provider: Postal: Department of Economics Duke University 213 Social Sciences Building Box 90097 Durham, NC 27708-0097
Phone: (919) 660-1800
Fax: (919) 684-8974
Web page:

No references listed on IDEAS
You can help add them by filling out this form.

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:duk:dukeec:02-10. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Department of Economics Webmaster)

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 references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link 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 profile, as there may be some citations waiting for confirmation.

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

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.