Nonlinear Exchange Rate Models: A Selective Overview

39 Pages Posted: 29 Jan 2006

See all articles by Lucio Sarno

Lucio Sarno

City University London - Sir John Cass Business School; Centre for Economic Policy Research (CEPR)

Date Written: May 2003

Abstract

This paper provides a selective overview of nonlinear exchange rate models recently proposed in the literature and assesses their contribution to understanding exchange rate behavior. Two key questions are examined. The first question is whether nonlinear autoregressive models of real exchange rates help resolve the purchasing power parity (PPP) puzzles. The second question is whether recently developed nonlinear, regime-switching vector equilibrium correction models of the nominal exchange rate can beat a random walk model, the standard benchmark in the exchange rate literature, in terms of out-of-sample forecasting performance. Finally, issues related to the adequateness of standard methods of evaluation of (linear and nonlinear) exchange rate models are discussed with reference to different forecast accuracy criteria.

Keywords: exchange rate, purchasing power parity, forecasting nonlinearity

JEL Classification: F31

Suggested Citation

Sarno, Lucio, Nonlinear Exchange Rate Models: A Selective Overview (May 2003). IMF Working Paper, Vol. , pp. 1-39, 2003. Available at SSRN: https://ssrn.com/abstract=879187

Lucio Sarno (Contact Author)

City University London - Sir John Cass Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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