Exchange rate forecasting on a napkin

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

Journal of International Money and Finance, 2020, vol. 104, issue C

Abstract: This paper shows that there are two regularities in foreign exchange markets in advanced countries with flexible regimes. First, real exchange rates are mean-reverting, as implied by the Purchasing Power Parity model. Second, the adjustment takes place via nominal exchange rates. These features of the data can be exploited, even on the back of a napkin, to generate nominal exchange rate forecasts that outperform the random walk. The secret is to avoid estimating the pace of mean reversion and assume that relative prices are unchanged. Direct forecasting, panel data techniques and non-linear models can outperform the random walk, but fail to beat this simple calibrated model.

Keywords: Forecasting; Exchange rates; Mean reversion; Purchasing power parity; Panel data (search for similar items in EconPapers)
JEL-codes: C32 F31 F37 F41 (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (20)

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Related works:
Working Paper: Exchange rate forecasting on a napkin (2018)
Working Paper: Exchange rate forecasting on a napkin (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:104:y:2020:i:c:s026156061830192x

DOI: 10.1016/j.jimonfin.2020.102168

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