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Exchange rate dynamics, forecasting and the microstructure approach: empirical evidence for an emerging market economy

José Sánchez-Fung

Macroeconomics and Finance in Emerging Market Economies, 2015, vol. 8, issue 1-2, 81-89

Abstract: This article investigates exchange rate dynamics and forecasting in an emerging market economy by incorporating elements from the market microstructure approach. The investigation finds that in the Dominican Republic imbalances between purchases and sales in the foreign exchange market are significant in explaining exchange rate dynamics over and above traditional purchasing power parity (PPP) fundamentals. The investigation runs a forecasting competition, and the preferred model beats a battery of competitors at the 3-month horizon. But an uncovered interest parity (UIP) specification outperforms the otherwise preferred model, a PPP benchmark and a first-order autoregression over 6- and 12-month forecast horizons.

Date: 2015
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DOI: 10.1080/17520843.2014.977929

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