Exchange Rate Determination: Single-Equation or Economy-Wide Models? A Test Against the Random Walk

Posted: 2 May 2011

See all articles by Giancarlo Gandolfo

Giancarlo Gandolfo

Accademia dei Lincei; CESifo (Center for Economic Studies and Ifo Institute)

Giovanna Paladino

IntesaSanpaolo; LUISS Economics Department

Pier Carlo Padoan

University of Rome I - Department of Public Economics

Date Written: May 3, 1989

Abstract

We first give a brief presentation of the existing single-equation structural models of exchange-rate determination and a survey of how the exchange rate is modeled in the main economy-wide macroeconometric models. We then show, with respect to the lira/$ exchange rate, that the out-of-sample predictive performance of the single-equation models is inferior to that of the simple random walk model. This confirms the thesis that only by moving away from these single-equation, semi-reduced form models towards suitable economy-wide macroeconometric models can one hope to beat the random walk. Following this course, we finally show that the Mark V version of our continuous time macroeconometric model of the Italian economy outperforms both the existing structural models and the random-walk process, in out-of-sample forecasting tests concerning the lira/$ exchange rate.

Keywords: Exchange rate, random walk, out-of-sample forecasting

JEL Classification: F31, F47

Suggested Citation

Gandolfo, Giancarlo and Paladino, Giovanna and Padoan, Pier Carlo, Exchange Rate Determination: Single-Equation or Economy-Wide Models? A Test Against the Random Walk (May 3, 1989). Journal of Banking and Finance, Vol. 14, pp. 965-992, November 1990. Available at SSRN: https://ssrn.com/abstract=1827938

Giancarlo Gandolfo (Contact Author)

Accademia dei Lincei ( email )

Via della Lungara 10
Rome, 00165
Italy

HOME PAGE: http://gandolfo.org

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

Giovanna Paladino

IntesaSanpaolo ( email )

Piazza San Carlo
Torino, 10121
Italy

LUISS Economics Department ( email )

Viale di Villa Massimo, 57
Rome, 00161
Italy

Pier Carlo Padoan

University of Rome I - Department of Public Economics ( email )

via del Castro Laurenziano, 9
Rome, RM 00161
Italy
+39 6 49766366 (Phone)
+39 6 4462040/4461964 (Fax)

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