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Comparing Forecast Performance of Exchange Rate Models

  • Lillie Lam

    (Research Department, Hong Kong Monetary Authority)

  • Laurence Fung

    (Research Department, Hong Kong Monetary Authority)

  • Ip-wing Yu

    (Research Department, Hong Kong Monetary Authority)

Registered author(s):

    Exchange-rate movement is regularly monitored by central banks for macroeconomic-analysis and market-surveillance purposes. Notwithstanding the pioneering study of Meese and Rogoff (1983), which shows the superiority of the random-walk model in out-of-sample exchange-rate forecast, there is some evidence that exchange-rate movement may be predictable at longer time horizons. This study compares the forecast performance of the Purchasing Power Parity model, Uncovered Interest Rate Parity model, Sticky Price Monetary model, the model based on the Bayesian Model Averaging technique, and a combined forecast of all the above models with benchmarks given by the random-walk model and the historical average return. Empirical results suggest that the combined forecast outperforms the benchmarks and generally yields better results than relying on a single model.

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    File URL: http://www.info.gov.hk/hkma/eng/research/working/pdf/HKMAWP08_08_full.pdf
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    Paper provided by Hong Kong Monetary Authority in its series Working Papers with number 0808.

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    Length: 23 pages
    Date of creation: Jun 2008
    Date of revision:
    Handle: RePEc:hkg:wpaper:0808
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    1. Jeffrey A. Frankel and Andrew K. Rose., 1995. "A Survey of Empirical Research on Nominal Exchange Rates," Center for International and Development Economics Research (CIDER) Working Papers C95-051, University of California at Berkeley.
    2. Carmen Fernandez & Eduardo Ley & Mark Steel, 1999. "Model uncertainty in cross-country growth regressions," Econometrics 9903003, EconWPA, revised 06 Oct 2001.
    3. Cheung, Yin-Wong & Chinn, Menzie & Garcia Pascual, Antonio, 2003. "Empirical Exchange Rate Models of the Nineties: Are Any Fit to Survive?," Santa Cruz Department of Economics, Working Paper Series qt5fc508pt, Department of Economics, UC Santa Cruz.
    4. Min, Chung-ki & Zellner, Arnold, 1993. "Bayesian and non-Bayesian methods for combining models and forecasts with applications to forecasting international growth rates," Journal of Econometrics, Elsevier, vol. 56(1-2), pages 89-118, March.
    5. Guy Meredith & Menzie D. Chinn, 1998. "Long-Horizon Uncovered Interest Rate Parity," NBER Working Papers 6797, National Bureau of Economic Research, Inc.
    6. Mark, Nelson C, 1995. "Exchange Rates and Fundamentals: Evidence on Long-Horizon Predictability," American Economic Review, American Economic Association, vol. 85(1), pages 201-18, March.
    7. 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.
    8. Richard Meese & Andrew K. Rose, 1989. "An empirical assessment of non-linearities in models of exchange rate determination," International Finance Discussion Papers 367, Board of Governors of the Federal Reserve System (U.S.).
    9. Chinn, Menzie D. & Meese, Richard A., 1995. "Banking on currency forecasts: How predictable is change in money?," Journal of International Economics, Elsevier, vol. 38(1-2), pages 161-178, February.
    10. K. J. Martijn Cremers, 2002. "Stock Return Predictability: A Bayesian Model Selection Perspective," Review of Financial Studies, Society for Financial Studies, vol. 15(4), pages 1223-1249.
    11. Avramov, Doron, 2002. "Stock return predictability and model uncertainty," Journal of Financial Economics, Elsevier, vol. 64(3), pages 423-458, June.
    12. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
    13. Frankel, Jeffrey A, 1979. "On the Mark: A Theory of Floating Exchange Rates Based on Real Interest Differentials," American Economic Review, American Economic Association, vol. 69(4), pages 610-22, September.
    14. Alexius, Annika, 2001. "Uncovered Interest Parity Revisited," Review of International Economics, Wiley Blackwell, vol. 9(3), pages 505-17, August.
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