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Forecasting the Yen/U.S. Dollar exchange rate: Empirical evidence from a capital enhanced relative PPP-based model

Axel Grossmann and Marc W. Simpson

Journal of Asian Economics, 2010, vol. 21, issue 5, 476-484

Abstract: This study uses a relative purchasing power parity (PPP) model based on price indexes (consumer, CPI or traded-goods price indexes, TPI), interest rate differentials, and a linear forecasting technique to determine the horizon over which such a model outperforms a random walk in forecasting the Yen/U.S. Dollar exchange rates out-of-sample. The results improve if one adjusts a simple CPI-based PPP-model by interest rate differentials, while the best results are obtained using a TPI-based PPP-model. For example, the TPI-based model, adjusted by interest rate differentials, is able to statistically significantly outperform the pure random walk starting at forecast horizons of 1 month.

Keywords: Yen/dollar; exchange; rate; Relative; purchasing; power; parity; Interest; rate; differentials; Forecasting; Short-term; horizons (search for similar items in EconPapers)
Date: 2010
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Handle: RePEc:eee:asieco:v:21:y:2010:i:5:p:476-484