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External Imbalances, Valuation Adjustments and Real Exchange Rate: Evidence of Predictability in an Emerging Economy

Jorge Selaive () and Pablo Pincheira ()

Working Papers Central Bank of Chile from Central Bank of Chile

Abstract: We evaluate the ability of a measure of external imbalances that combines the trade and the financial channels to forecast the real effective exchange rate for Chile. By making use of a quarterly database of external assets and liabilities for the period 1983 to 2005, and employing a recently developed test of out-of-sample predictive ability, we show that this measure is able to predict the real exchange rate at horizons of up to 2 years. Out-of-sample evidence of predictability tends to get stronger as the size of the window used to estimate the parameters increases. This is probably because of the greater relative importance of the external balance in the dynamics of the exchange rate in the last few years, or because of the increasing precision of parameter estimates with the sample size. When we break down our measure of external imbalances into its three components: exports to imports ratio, exports to assets ratio and assets to liabilities ratio, we find that out-of-sample predictability is mainly driven by the last two ratios.

Date: 2008-03
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Journal Article: External imbalance, valuation adjustments and real Exchange rate: evidence of predictability in an emerging economy (2011) Downloads
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