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Exchange Rate Predictability in a Changing World

  • Joseph P. Byrne

    (Department of Economics, Heriot-Watt University, UK)

  • Dimitris Korobilis

    ()

    (Department of Economics, Adam Smith Business School, University of Glasgow, UK)

  • Pinho J. Ribeiro

    (Department of Economics, Adam Smith Business School, University of Glasgow, UK)

An expanding literature articulates the view that Taylor rules are helpful in predicting exchange rates. In a changing world however, Taylor rule parameters may be subject to structural instabilities, for example during the Global Financial Crisis. This paper forecasts exchange rates using such Taylor rules with Time Varying Parameters (TVP) estimated by Bayesian methods. In core out-of-sample results, we improve upon a random walk benchmark for at least half, and for as many as eight out of ten, of the currencies considered. This contrasts with a constant parameter Taylor rule model that yields a more limited improvement upon the benchmark. In further results, Purchasing Power Parity and Uncovered Interest Rate Parity TVP models beat a random walk benchmark, implying our methods have some generality in exchange rate prediction.

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Paper provided by The Rimini Centre for Economic Analysis in its series Working Paper Series with number 06_14.

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Date of creation: Feb 2014
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Handle: RePEc:rim:rimwps:06_14
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