Are Exchange Rates Really Random Walks? Some Evidence Robust to Parameter Instability

Barbara Rossi

International Finance from University Library of Munich, Germany

Abstract: Many authors have documented that it is challenging to explain exchange rate fluctuations with macroeconomic fundamentals: a random walk forecasts future exchange rates better than existing macroeconomic models. This paper applies newly developed tests for nested model that are robust to the presence of parameter instability. The empirical evidence shows that for some countries we can reject the hypothesis that exchange rates are random walks. This raises the possibility that economic models were previously rejected not because the fundamentals are completely unrelated to exchange rate fluctuations, but because the relationship is unstable over time and, thus, difficult to capture by Granger Causality tests or by forecast comparisons. We also analyze forecasts that exploit the time variation in the parameters and find that, in some cases, they can improve over the random walk.

Keywords: forecasting; exchange rates; parameter instability; random walks (search for similar items in EconPapers)
JEL-codes: C52 C53 (search for similar items in EconPapers)
Date: 2005-03-19
Note: Type of Document - pdf
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

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Related works:
Journal Article: ARE EXCHANGE RATES REALLY RANDOM WALKS? SOME EVIDENCE ROBUST TO PARAMETER INSTABILITY (2006)
Working Paper: Are Exchange Rates Really Random Walks? Some Evidence Robust to Parameter Instability (2005)
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Persistent link: https://EconPapers.repec.org/RePEc:wpa:wuwpif:0503006

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