Exchange rate predictability and a monetary model with time-varying cointegration coefficients

Cheolbeom Park and Sookyung Park

Journal of International Money and Finance, 2013, vol. 37, issue C, 394-410

Abstract: Many studies have pointed out that the underlying relations and functions for the monetary model (e.g. the PPP relation, the money-demand function, monetary policy rule, etc.) have undergone parameter instabilities and that the relation between exchange rates and macro fundamentals is unstable due to the shift in the economic models in foreign exchange traders' views or the scapegoat effect in Bacchetta and van Wincoop (2009). Facing this, we consider a monetary model with time-varying cointegration coefficients in order to understand exchange rate movements. We provide statistical evidence against the standard monetary model with constant cointegration coefficients but find favorable evidence for the time-varying cointegration relationship between exchange rates and monetary fundamentals. Furthermore, we demonstrate that deviations between the exchange rate and fundamentals from the time-varying cointegration relation have strong predictive power for future changes in exchange rates through in-sample analysis, out-of-sample analysis, and directional accuracy tests.

Keywords: Exchange rate; Monetary model; Predictability; Time-varying cointegration (search for similar items in EconPapers)
JEL-codes: F31 F47 (search for similar items in EconPapers)
Date: 2013
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (28)

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Working Paper: Exchange Rate Predictability and a Monetary Model with Time-varying Cointegration Coefficients (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:37:y:2013:i:c:p:394-410

DOI: 10.1016/j.jimonfin.2013.05.003

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