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The Exchange Rate Forecasting Puzzle

  • Francis Vitek

    (University of British Columbia)

We survey and update the empirical literature concerning the predictability of nominal exchange rates using structural macroeconomic models over the recent floating exchange rate period. In particular, we consider both flexible and sticky price versions of the monetary model of nominal exchange rate determination. In agreement with the existing empirical literature, we find that nominal exchange rate movements are difficult to forecast, with a random walk generally dominating the monetary model in terms of predictive accuracy conditional on observed monetary fundamentals at all horizons.

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File URL: http://econwpa.repec.org/eps/if/papers/0509/0509005.pdf
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Paper provided by EconWPA in its series International Finance with number 0509005.

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Length: 17 pages
Date of creation: 14 Sep 2005
Date of revision:
Handle: RePEc:wpa:wuwpif:0509005
Note: Type of Document - pdf; pages: 17
Contact details of provider: Web page: http://econwpa.repec.org

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  1. Bennett T McCallum & Edward Nelson, 2001. "Monetary Policy for an Open Economy: An Alternative Framework with Optimising Agents and Sticky Prices," Discussion Papers 05, Monetary Policy Committee Unit, Bank of England.
  2. Mark, Nelson C. & Sul, Donggyu, 2001. "Nominal exchange rates and monetary fundamentals: Evidence from a small post-Bretton woods panel," Journal of International Economics, Elsevier, vol. 53(1), pages 29-52, February.
  3. Richard Meese & Kenneth S. Rogoff, 1982. "The out-of-sample failure of empirical exchange rate models: sampling error or misspecification?," International Finance Discussion Papers 204, Board of Governors of the Federal Reserve System (U.S.).
  4. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," Journal of Political Economy, University of Chicago Press, vol. 103(3), pages 624-60, June.
  5. Frenkel, Jacob A, 1976. " A Monetary Approach to the Exchange Rate: Doctrinal Aspects and Empirical Evidence," Scandinavian Journal of Economics, Wiley Blackwell, vol. 78(2), pages 200-224.
  6. Frankel, Jeffrey, 1995. "How Well Do Foreign Exchange Markets Function: Might a Tobin Tax Help?," Center for International and Development Economics Research (CIDER) Working Papers 233420, University of California-Berkeley, Department of Economics.
  7. Willem H. Buiter & Marcus Miller, 1991. "Real Exchange Rate Overshooting and the Output Cost of Bringing Down Inflation," NBER Chapters, in: International Volatility and Economic Growth: The First Ten Years of The International Seminar on Macroeconomics, pages 239-277 National Bureau of Economic Research, Inc.
  8. Adolfson, Malin, 2001. "Monetary Policy with Incomplete Exchange Rate Pass-Through," SSE/EFI Working Paper Series in Economics and Finance 476, Stockholm School of Economics.
  9. Giancarlo Corsetti & Paolo Pesenti, 2001. "International dimensions of optimal monetary policy," Staff Reports 124, Federal Reserve Bank of New York.
  10. Monacelli, Tommaso, 2003. "Monetary policy in a low pass-through environment," Working Paper Series 0227, European Central Bank.
  11. Richard Clarida & Jordi Gali & Mark Gertler, 2002. "A Simple Framework for International Monetary Policy Analysis," NBER Working Papers 8870, National Bureau of Economic Research, Inc.
  12. 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.
  13. Christopher J. Neely & Lucio Sarno, 2002. "How well do monetary fundamentals forecast exchange rates?," Working Papers 2002-007, Federal Reserve Bank of St. Louis.
  14. David Backus, 1982. "Empirical Models of the Exchange Rate: Separating the Wheat from the Chaff," Working Papers 463, Queen's University, Department of Economics.
  15. Mark Gertler & Simon Gilchrist & Fabio M. Natalucci, 2007. "External Constraints on Monetary Policy and the Financial Accelerator," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(2-3), pages 295-330, 03.
  16. Meese, R. & Rogoff, K., 1988. "Was It Real? The Exchange Rate-Interest Differential Ralation Over The Modern Floating-Rate Period," Working papers 368, Wisconsin Madison - Social Systems.
  17. Mussa, Michael, 1979. "Empirical regularities in the behavior of exchange rates and theories of the foreign exchange market," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 11(1), pages 9-57, January.
  18. 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.
  19. Garry J. Schinasi & P. A. V. B. Swamy, 1987. "The out-of-sample forecasting performance of exchange rate models when coefficients are allowed to change," International Finance Discussion Papers 301, Board of Governors of the Federal Reserve System (U.S.).
  20. Wolff, Christian C. P., 1988. "Exchange rates, innovations and forecasting," Journal of International Money and Finance, Elsevier, vol. 7(1), pages 49-61, March.
  21. Meese, Richard A & Rose, Andrew K, 1990. "Nonlinear, Nonparametric, Nonessential Exchange Rate Estimation," American Economic Review, American Economic Association, vol. 80(2), pages 192-96, May.
  22. Canova, Fabio, 1993. "Modelling and forecasting exchange rates with a Bayesian time-varying coefficient model," Journal of Economic Dynamics and Control, Elsevier, vol. 17(1-2), pages 233-261.
  23. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  24. Groen, Jan J. J., 2000. "The monetary exchange rate model as a long-run phenomenon," Journal of International Economics, Elsevier, vol. 52(2), pages 299-319, December.
  25. Wolff, Christian C P, 1987. "Time-Varying Parameters and the Out-of-Sample Forecasting Performance of Structural Exchange Rate Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 5(1), pages 87-97, January.
  26. 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.
  27. 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.
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