Exchange rate prediction redux: New models, new data, new currencies

Yin-Wong Cheung, Menzie Chinn, Antonio Garcia Pascual and Yi Zhang

Journal of International Money and Finance, 2019, vol. 95, issue C, 332-362

Abstract: Previous assessments of nominal exchange rate determination, following Meese and Rogoff (1983) have focused upon a narrow set of models. Cheung et al. (2005) augmented the usual suspects with productivity based models, and “behavioral equilibrium exchange rate” models, and assessed performance at horizons of up to 5 years. In this paper, we further expand the set of models to include Taylor rule fundamentals, yield curve factors, and incorporate shadow rates and risk and liquidity factors. The performance of these models is compared against the random walk benchmark. The models are estimated in error correction and first-difference specifications. We examine model performance at various forecast horizons (1 quarter, 4 quarters, 20 quarters) using differing metrics (mean squared error, direction of change), as well as the “consistency” test of Cheung and Chinn (1998). The purchasing power parity estimated in the error correction form delivers the best performance at long horizons by a mean squared error measure. Moreover, along a direction-of-change dimension, certain structural models do outperform a random walk with statistical significance. While one finds that these forecasts are cointegrated with the actual values of exchange rates, in most cases, the elasticity of the forecasts with respect to the actual values is different from unity. Overall, model/specification/currency combinations that work well in one period and one performance metric will not necessarily work well in another period and alternative performance metric.

Keywords: Exchange rates; Monetary model; Interest rate parity; Behavioral equilibrium exchange rate model; Forecasting performance (search for similar items in EconPapers)
JEL-codes: F31 F47 (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (60)

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Related works:
Working Paper: Exchange rate prediction redux: new models, new data, new currencies (2017)
Working Paper: Exchange Rate Prediction Redux: New Models, New Data, New Currencies (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:95:y:2019:i:c:p:332-362

DOI: 10.1016/j.jimonfin.2018.03.010

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