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“Forecasting emerging market currencies: Are inflation expectations useful?”

Author

Listed:
  • Alberto Fuertes

    (Banco de España)

  • Simón Sosvilla-Rivero

    (Complutense Institute for Economic Analysis, Universidad Complutense de Madrid.)

Abstract

This paper investigates the empirical relevance of inflation expectations in forecasting exchange rates. To that end, we use an expectation version of purchasing power parity (EVRPPP) based on the differential of inflation expectations derived from inflation-indexed bonds for Brazil, Colombia, Chile, India, Mexico, Poland, South Africa, South Korea and Turkey. Using monthly data on exchange rates and on the inflation expectations, we find that our predictors are not significantly better than the random walk model, although, with the exception of the South Korean Won, they outperform the random walk when considering the sign of the rate of change. We also find strongly support Granger causality running from exchange rate to the forecasts based on EVRPPP and only partial evidence of Granger causality running the other way around. Finally, our results suggest that 1-year, 5-year and 10-year inflation expectations are mutually consistent.

Suggested Citation

  • Alberto Fuertes & Simón Sosvilla-Rivero, 2019. "“Forecasting emerging market currencies: Are inflation expectations useful?”," IREA Working Papers 201918, University of Barcelona, Research Institute of Applied Economics, revised Oct 2019.
    • Handle: RePEc:ira:wpaper:201918
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    File URL: http://www.ub.edu/irea/working_papers/2019/201918.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    Forecasting; Purchasing power parity; Exchange rates; Inflation expectations. JEL classification: C22; F30.;
    All these keywords.

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes

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