Exchange Rate Prediction Redux: New Models, New Data, New Currencies

58 Pages Posted: 13 Feb 2017

See all articles by Yin-Wong Cheung

Yin-Wong Cheung

City University of Hong Kong - Department of Economics & Finance; University of California, Santa Cruz - Department of Economics; University of California at Santa Cruz - Department of Economics

Menzie David Chinn

University of Wisconsin, Madison - Robert M. La Follette School of Public Affairs and Department of Economics; National Bureau of Economic Research (NBER)

Antonio I. Garcia Pascual

International Monetary Fund (IMF) - Western Hemisphere Department; CESifo (Center for Economic Studies and Ifo Institute)

Yi Zhang

University of Wisconsin - Madison - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: February 10, 2017

Abstract

Previous assessments of nominal exchange rate determination, following Meese and Rogoff (1983) have focused upon a narrow set of models. Cheung et al. (2005) augmented the usual suspects with productivity based models, and “behavioral equilibrium exchange rate” models, and assessed performance at horizons of up to 5 years. In this paper, we further expand the set of models to include Taylor rule fundamentals, yield curve factors, and incorporate shadow rates and risk and liquidity factors. The performance of these models is compared against the random walk benchmark. The models are estimated in error correction and first-difference specifications. We examine model performance at various forecast horizons (1 quarter, 4 quarters, 20 quarters) using differing metrics (mean squared error, direction of change), as well as the “consistency” test of Cheung and Chinn (1998). No model consistently outperforms a random walk, by a mean squared error measure, although purchasing power parity does fairly well. Moreover, along a direction-of-change dimension, certain structural models do outperform a random walk with statistical significance. While one finds that these forecasts are cointegrated with the actual values of exchange rates, in most cases, the elasticity of the forecasts with respect to the actual values is different from unity. Overall, model/specification/currency combinations that work well in one period will not necessarily work well in another period.

Keywords: Exchange Rates, Monetary Model, Interest Rate Parity, Behavioral Equilibrium Exchange Rate Model, Forecasting Performance

JEL Classification: F31, F47

Suggested Citation

Cheung, Yin-Wong and Chinn, Menzie David and Garcia Pascual, Antonio I. and Zhang, Yi, Exchange Rate Prediction Redux: New Models, New Data, New Currencies (February 10, 2017). ECB Working Paper No. 2018. Available at SSRN: https://ssrn.com/abstract=2916213

Yin-Wong Cheung (Contact Author)

City University of Hong Kong - Department of Economics & Finance ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong

University of California, Santa Cruz - Department of Economics ( email )

435 Engineering 2
Santa Cruz, CA 95064
United States
831-459-4247 (Phone)
831-459-5077 (Fax)

University of California at Santa Cruz - Department of Economics ( email )

1156 High Street
Santa Cruz, CA 95064
United States

Menzie David Chinn

University of Wisconsin, Madison - Robert M. La Follette School of Public Affairs and Department of Economics ( email )

1180 Observatory Drive
Madison, WI 53706-1393
United States
608-262-7397 (Phone)
608-262-2033 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Antonio I. Garcia Pascual

International Monetary Fund (IMF) - Western Hemisphere Department ( email )

700 19th Street NW
Washington, DC 20431
United States

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

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

Yi Zhang

University of Wisconsin - Madison - Department of Economics ( email )

1180 Observatory Drive
Madison, WI 53706
United States
6086093218 (Phone)

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