FORECASTING THE USD/COP EXCHANGE RATE: A RANDOM WALK WITH A VARIABLE DRIFT

Peter Rowland

No 2736, Borradores de Economia from Banco de la Republica

Abstract: This study develops three exchange rate models as well as a simple statistical model defined as a random walk with a variable drift. The exchange rate models all use the purchasing power parity hypothesis to account for the long-term relationships between prices and the exchange rate, together with error correction models to represent any shortterm dynamics. The models are estimated for the USD/COP rate of exchange, and their forecast performance is compared to that of a simple random walk as well as to that of the random walk with a variable drift term. Two of the models are shown to outperform the simple random walk on the 12 and 24-months forecasting horizon. However, all the models are outperformed by the random walk with a variable drift, where the drift term is estimated using a Kalman filter. The results suggest that fundamental models might only be a useful tool for forecasting of the exchange rate in the very long run.

Pages: 52
Date: 2003-08-31
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:col:000094:002736

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