Nonlinear exchange rate predictability

Carlos Felipe López-Suárez and Antonio Rodriguez-Lopez ()

Journal of International Money and Finance, 2011, vol. 30, issue 5, 877-895

Abstract: We study whether the nonlinear behavior of the real exchange rate can help us account for the lack of predictability of the nominal exchange rate. We construct a smooth nonlinear error-correction model that allows us to test the hypotheses of nonlinear predictability of the nominal exchange rate and nonlinear behavior on the real exchange rate in the context of a fully specified cointegrated system. Using a panel of 19 countries and three numeraires, we find evidence of nonlinear predictability of the nominal exchange rate and of nonlinear mean reversion of the real exchange rate. Out-of-sample Theil's U -statistics show a higher forecast precision of the nonlinear model than the one obtained with a random walk specification. Although the robustness of the out-of-sample results over different forecast windows is somewhat limited, we are able to obtain significant predictability gains--from a parsimonious structural model with PPP fundamentals--even at short-run horizons.

Keywords: Exchange; rates; Predictability; Nonlinearities; Purchasing; power; parity (search for similar items in EconPapers)
Date: 2011
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Citations: View citations in EconPapers (7)

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Working Paper: Nonlinear Exchange Rate Predictability (2010)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:30:y:2011:i:5:p:877-895

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