Can long-horizon forecasts beat the random walk under the Engel-West explanation?

Charles Engel, Jian Wang and Jason Wu (jason.j.wu.travel@gmail.com)

No 36, Globalization Institute Working Papers from Federal Reserve Bank of Dallas

Abstract: Engel and West (EW, 2005) argue that as the discount factor gets closer to one, present-value asset pricing models place greater weight on future fundamentals. Consequently, current fundamentals have very weak forecasting power and exchange rates appear to follow approximately a random walk. We connect the Engel-West explanation to the studies of exchange rates with long-horizon regressions. We find that under EW's assumption that fundamentals are I(1) and observable to the econometrician, long-horizon regressions generally do not have significant forecasting power. However, when EW's assumptions are violated in a particular way, our analytical results show that there can be substantial power improvements for long-horizon regressions, even if the power of the corresponding short-horizon regression is low. We simulate population R squared for long-horizon regressions in the latter setting, using Monetary and Taylor Rule models of exchange rates calibrated to the data. Simulations show that long-horizon regression can have substantial forecasting power for exchange rates.

Keywords: Foreign exchange rates; Financial markets; Asset pricing; Forecasting; Random walks (Mathematics); Regression analysis (search for similar items in EconPapers)
Date: 2009
New Economics Papers: this item is included in nep-cba, nep-for, nep-ifn and nep-opm
References: Add references at CitEc
Citations: View citations in EconPapers (5)

Downloads: (external link)
http://dallasfed.org/assets/documents/institute/wpapers/2009/0036.pdf (application/pdf)
Our link check indicates that this URL is bad, the error code is: 404 Not Found (http://dallasfed.org/assets/documents/institute/wpapers/2009/0036.pdf [301 Moved Permanently]--> https://dallasfed.org/assets/documents/institute/wpapers/2009/0036.pdf [301 Moved Permanently]--> https://www.dallasfed.org/assets/documents/institute/wpapers/2009/0036.pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:fip:feddgw:36

Access Statistics for this paper

More papers in Globalization Institute Working Papers from Federal Reserve Bank of Dallas Contact information at EDIRC.
Bibliographic data for series maintained by Amy Chapman (amy.chapman@dal.frb.org).