Forecasting emerging market currencies: Are inflation expectations useful?

Alberto Fuertes () and Simon Sosvilla-Rivero
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Alberto Fuertes: Banco de España

No 201918, IREA Working Papers from University of Barcelona, Research Institute of Applied Economics

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: C22; F30. (search for similar items in EconPapers)
Pages: 31 pages
Date: 2019-10, Revised 2019-10
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Persistent link: https://EconPapers.repec.org/RePEc:ira:wpaper:201918

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