Real exchange rate forecasting: a calibrated half-life PPP model can beat the random walk

Michele Ca’ Zorzi and Michał Rubaszek
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Michele Ca’ Zorzi: European Central Bank
Authors registered in the RePEc Author Service: Michele Ca' Zorzi

No 123, NBP Working Papers from Narodowy Bank Polski

Abstract: This paper brings two new insights into the Purchasing Power Parity (PPP) debate. First, even if PPP is thought to hold only in the long run, we show that a half-life PPP model outperforms the random walk in real exchange rate forecasting, also at short-term horizons. Second, we show that this result holds as long as the speed of adjustment to the sample mean is imposed and not estimated. The reason is that the estimation error of the pace of convergence distorts the results in favor of the random walk model, even if the PPP holds in the long-run.

Keywords: Exchange rate forecasting; purchasing power parity; half-life (search for similar items in EconPapers)
JEL-codes: C32 F31 F37 (search for similar items in EconPapers)
Pages: 21
Date: 2012
New Economics Papers: this item is included in nep-for, nep-mon and nep-opm
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Citations: View citations in EconPapers (2)

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Working Paper: Real exchange rate forecasting: a calibrated half-life PPP model can beat the random walk (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:nbp:nbpmis:123

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