Forecasting Emerging Market Currencies: Are Inflation Expectations Useful?

31 Pages Posted: 31 Oct 2019

See all articles by Alberto Fuertes

Alberto Fuertes

Banco de España

Simon Sosvilla-Rivero

UCM Institute for Economic Analysis

Date Written: October 21, 2019

Abstract

This paper investigates the empirical relevance of inflation expectations in forecasting exchange rates. To that end, we use an expectation version of purchasing power parity (EVRPPP) based on the differential of inflation expectations derived from inflation-indexed bonds for Brazil, Colombia, Chile, India, Mexico, Poland, South Africa, South Korea and Turkey. Using monthly data on exchange rates and on the inflation expectations, we find that our predictors are not significantly better than the random walk model, although, with the exception of the South Korean Won, they outperform the random walk when considering the sign of the rate of change. We also find strongly support Granger causality running from exchange rate to the forecasts based on EVRPPP and only partial evidence of Granger causality running the other way around. Finally, our results suggest that 1-year, 5-year and 10-year inflation expectations are mutually consistent.

Keywords: Forecasting, Purchasing power parity, Exchange rates, Inflation expectations

JEL Classification: 22, F30

Suggested Citation

Fuertes, Alberto and Sosvilla-Rivero, Simon, Forecasting Emerging Market Currencies: Are Inflation Expectations Useful? (October 21, 2019). Available at SSRN: https://ssrn.com/abstract=3473147

Alberto Fuertes

Banco de España ( email )

Alcala 50
Madrid 28014
Spain

Simon Sosvilla-Rivero (Contact Author)

UCM Institute for Economic Analysis ( email )

Carretera de Humera s/n
Madrid, Madrid 28223
Spain
+34913932626 (Phone)

HOME PAGE: http://www.ucm.es/info/ecocuan/ssr/

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