Nonlinear Exchange Rate Predictability

Carlos Felipe Lopez Suarez and Jose Antonio Rodriguez Lopez ()
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Jose Antonio Rodriguez Lopez: Department of Economics, University of California-Irvine
Authors registered in the RePEc Author Service: Antonio Rodriguez-Lopez ()

No 80911, Working Papers from University of California-Irvine, Department of Economics

Abstract: We study whether the nonlinear behavior of the real exchange rate can help us account for the lack of predictability of the nominal exchange rate. We construct a smooth nonlinear error-correction model that allows us to test the hypotheses of nonlinear predictability of the nominal exchange rate and nonlinear behavior on the real exchange rate in the context of a fully specified cointegrated system. Using a panel of 19 countries and three numeraires, we find evidence of nonlinear predictability of the nominal exchange rate and of nonlinear mean reversion of the real exchange rate. Out-of-sample Theil's U-statistics show a higher forecast precision of the nonlinear model than the one obtained with a random walk specification. Although the robustness of the out-of-sample results over different forecast windows is somewhat limited, we are able to obtain significant predictability gains--from a parsimonious structural model with PPP fundamentals--even at short-run horizons.

Keywords: Exchange rates; Predictability; Nonlinearities; Purchasing power parity (search for similar items in EconPapers)
JEL-codes: C53 F31 F47 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2008-12, Revised 2010-09
New Economics Papers: this item is included in nep-cba, nep-for, nep-ifn and nep-opm
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Journal Article: Nonlinear exchange rate predictability (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:irv:wpaper:080911

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