Exchange Rate Forecasting: The Errors We've Really Made

35 Pages Posted: 4 Mar 2002

See all articles by Jon Faust

Jon Faust

Board of Governors of the Federal Reserve - Division of International Finance; Johns Hopkins University

John H. Rogers

Board of Governors of the Federal Reserve System - Trade and Financial Studies Section

Jonathan H. Wright

Johns Hopkins University - Department of Economics

Date Written: December 2001

Abstract

We examine the forecasting performance of standard macro models of exchange rates in real time, using dozens of different vintages of the OECDs Main Economic Indicators database. We calculate out-of-sample forecasts as they would have been made at the time, and compare them to a random walk alternative. The resulting "time series" of forecast performance indicates that both data revisions and changes in the sample period typically have large effects on exchange rate predictability. We show that the favorable evidence of long-horizon exchange rate predictability for the DM and Yen in Mark (1995) is present in only a narrow two-year window of data vintages around that used by Mark. In addition, approximately one-third of the improved forecasting performance of Mark's monetary model over a random walk is eventually undone by data revisions. Related to this, we find the models consistently perform better using original release data than using fully revised data. Finally, we find that model-based exchange rate forecasts are sometimes better when using Federal Reserve Staff forecasts of future fundamentals instead of actual future values of fundamentals. This contradicts a cherished presumption in the literature that dates all the way back to Meese and Rogoff (1983).

Keywords: monetary model, real time data, random walk

JEL Classification: F31, C53

Suggested Citation

Faust, Jon and Rogers, John H. and Wright, Jonathan H., Exchange Rate Forecasting: The Errors We've Really Made (December 2001). FRB International Finance Discussion Paper No. 714. Available at SSRN: https://ssrn.com/abstract=302022 or http://dx.doi.org/10.2139/ssrn.302022

Jon Faust

Board of Governors of the Federal Reserve - Division of International Finance ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States
202-452-2328 (Phone)
202-736-5638 (Fax)

Johns Hopkins University

Baltimore, MD 20036-1984
United States

John H. Rogers (Contact Author)

Board of Governors of the Federal Reserve System - Trade and Financial Studies Section ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States
202-452-2873 (Phone)
202-736-5638 (Fax)

Jonathan H. Wright

Johns Hopkins University - Department of Economics ( email )

3400 Charles Street
Baltimore, MD 21218-2685
United States

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