Dynamic Forecasting of Monetary Exchange Rate Models: Evidence from Cointegration

Abstract:     
The Frenkel-Bilson and Dornbusch-Frankel monetary exchange rate models are used to estimate the out-of sample forecasting performance for the U.S. dollar/Canadian dollar exchange rate. By using Johansen's multivariate cointegration, up to three cointegrating vectors were found between the exchange rate and macroeconomic fundamentals. This means that there is a long-run relationship between the exchange rate and economic fundamentals. Based on error correction models, two monetary models outperform the random walk model at the three-, six-, and 12-month forecasting horizons. Therefore, monetary exchange rate models are still useful in forecasting exchange rates.

Number of Pages in PDF File: 14

Keywords: Exchange Rate Model, Cointegration, Error-Correction Model

JEL Classification: F31

Accepted Paper Series