Forecasting Foreign Exchange Rate Assuming PPP Conditions: Empirical Evidence Using VAR

Fayad, Catherine; Fortich, Roberto; Velez-Pareja, Ignacio

Forecasting Foreign Exchange Rate Assuming PPP Conditions: Empirical Evidence Using VAR

Estudios Gerenciales. Journal of Management and Economics of Iberoamerica, Vol. 25, No. 113, pp. 211-226, October-December 2009. (Spanish version)

18 Pages Posted: 9 May 2009 Last revised: 16 Feb 2010

See all articles by Catherine Fayad

Roberto Fortich

Universidad Tecnologica de Bolivar Department of Finance and International Business - Instituto de Estudios para el Desarrollo (IDE)

Ignacio Velez-Pareja

Grupo Consultor CAV Capital Advisory & Valuation

Date Written: May 8, 2009

Abstract

In this paper we evaluate a set of Colombian exchange rate forecasts during 1995-2005, using a Purchasing Power of Parity Exchange Rate Model (PPPER). Our first finding is that the computed forecasts seem to validate the use of this model under certain conditions given that, theoretically, it does a good work in predicting the long-term behavior of the nominal exchange rate. Our second finding included a comparative analysis of out-of-sample forecasts (saving the 2001-2005 historical data) between the PPP-based forecast models, and the Vector Autoregresive (VAR) ones. The VAR method has a better forecasting performance, according to the RMSE, MAE and U-Theil measures.

Keywords: Foreign exchange, time-series model, financial forecasting

JEL Classification: F31, C22, G17

Suggested Citation: Suggested Citation

Fayad, Catherine and Fortich, Roberto Carlos and Velez-Pareja, Ignacio, Forecasting Foreign Exchange Rate Assuming PPP Conditions: Empirical Evidence Using VAR (May 8, 2009). Estudios Gerenciales. Journal of Management and Economics of Iberoamerica, Vol. 25, No. 113, pp. 211-226, October-December 2009. (Spanish version), Available at SSRN: https://ssrn.com/abstract=1401538