Real Exchange Rate Forecasting and PPP: This Time the Random Walk Loses

Michele Ca' Zorzi, Jakub Mućk and Michał Rubaszek

Open Economies Review, 2016, vol. 27, issue 3, No 8, 585-609

Abstract: Abstract This paper brings four new insights into the Purchasing Power Parity (PPP) debate. First, we show that a half-life PPP (HL) model is able to forecast real exchange rates better than the random walk (RW) model at both short and long-term horizons. Second, we find that this result holds if the speed of adjustment to the sample mean is calibrated at reasonable values rather than estimated. Third, we find that it is preferable to calibrate, rather than to elicit as a prior, the parameter determining the speed of adjustment to PPP. Fourth, for most currencies in our sample, the HL model outperforms the RW also in terms of nominal exchange rate forecasting.

Keywords: Exchange rate forecasting; Purchasing power parity; Half-life (search for similar items in EconPapers)
JEL-codes: C32 F31 F37 (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (20)

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Related works:
Working Paper: Real exchange rate forecasting and ppp: this time the random walk loses (2015)
Working Paper: Real exchange rate forecasting: a calibrated half-life PPP model can beat the random walk (2013)
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DOI: 10.1007/s11079-015-9386-4

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