Why is it so difficult to beat the random walk forecast of exchange rates?

Lutz Kilian and Mark Taylor

No 88, Working Paper Series from European Central Bank

Abstract: We propose a nonlinear econometric model that can explain both the observed volatility and the persistence of real and nominal exchange rates. The model implies that near equilibrium, the nominal exchange rate will be well approximated by a random walk process. Large departures from fundamentals, in contrast, imply mean-reverting behavior toward fundamentals. Moreover, the predictability of the nominal exchange rate relative to the random walk benchmark tends to improve at longer horizons. We test the implications of the model and find strong evidence of exchange rate predictability at horizons of two to three years, but not at shorter horizons JEL Classification: F31, F47, C53

Keywords: economic models of exchange rate determination; long-horizon regression tests; purchasing power parity; random walk; real exchange rate (search for similar items in EconPapers)
Date: 2001-11
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Citations: View citations in EconPapers (68)

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Related works:
Journal Article: Why is it so difficult to beat the random walk forecast of exchange rates? (2003)
Working Paper: Why is it so Difficult to Beat the Random Walk Forecast of Exchange Rates? (2001)
Working Paper: Why Is It So Difficult to Beat the Random Walk Forecast of Exchange Rates? (2001)
Working Paper: Why is it so difficult to beat the Random Walk Forecast of Exchange Rates? (2001)
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:200188

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