Forecasting the Spot Exchange Rate with the Term Structure of Forward Premia: Multivariate Threshold Cointegration

Christian Wolff and Michel R van Tol

No 4958, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: In this paper we develop a multivariate threshold vector error correction model of spot and forward exchange rates that allows for different forms of equilibrium reversion in each of the cointegrating residual series. By introducing the notion of an indicator matrix to differentiate between the various regimes in the set of nonlinear processes we provide a convenient framework for estimation by OLS. Empirically, out-of sample forecasting exercises demonstrate its superiority over a linear VECM, while being unable to out-predict a (driftless) random walk model. As such we provide empirical evidence against the findings of Clarida and Taylor (1997).

Keywords: Multivariate threshold cointegration; Tar models; Foreign exchange (search for similar items in EconPapers)
JEL-codes: C51 C53 F31 (search for similar items in EconPapers)
Date: 2005-03
New Economics Papers: this item is included in nep-ecm, nep-ets, nep-fmk and nep-ifn
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Citations: View citations in EconPapers (2)

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