Balance of payments flows and exchange rate prediction in Japan

Nikolas Müller-Plantenberg ()

No 2012/09, Working Papers in Economic Theory from Universidad Autónoma de Madrid (Spain), Department of Economic Analysis (Economic Theory and Economic History)

Abstract: Monetary models of exchange rates tend to focus on inflation differentials to explain exchange rate movements. This paper assesses the ability of currency flows to predict exchange rate changes. The focus is on Japan. Currency flows are assumed to depend on the level of the current account and on the international investment position, where the latter is used as a proxy for international debt repayments. A state space model is used to predict simultaneously the exchange rate and its determinants. Using rolling regressions and out-of-sample predictions, it is shown that a model featuring currency flows can predict the direction of exchange rate movements better than a random walk (with or without drift). However, as happens with standard macroeconomic models, the model is not able to outperform a random walk in terms of the mean square prediction error criterion.

Keywords: balance of payments flows; international investment position; exchange rate prediction; out-of-sample prediction; random walk. (search for similar items in EconPapers)
JEL-codes: C22 C53 F31 F32 F34 F37 (search for similar items in EconPapers)
Pages: 22 pages
Date: 2012-03
New Economics Papers: this item is included in nep-cba, nep-for and nep-mon
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