Exchange rate forecasting on a napkin

Michele Ca' Zorzi and Michał Rubaszek

No GRU_2018_025, GRU Working Paper Series from City University of Hong Kong, Department of Economics and Finance, Global Research Unit

Abstract: This paper shows that there are two regularities in foreign exchange markets in advanced countries with flexible regimes. First, real exchange rates are mean-reverting, as implied by the Purchasing Power Parity model. Second, the adjustment takes place via nominal exchange rates. These features of the data can be exploited, even on the back of a napkin, to generate nominal exchange rate forecasts that outperform the random walk. The secret is to avoid estimating the pace of mean reversion and assume that relative prices are unchanged. Direct forecasting or panel data techniques are better than the random walk but fail to beat this simple calibrated model.

Keywords: exchange rates; forecasting; Purchasing Power Parity; panel data; mean reversion (search for similar items in EconPapers)
JEL-codes: C32 F31 F37 F41 (search for similar items in EconPapers)
Pages: 15 pages
Date: 2018-12-27
New Economics Papers: this item is included in nep-for
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https://www.cb.cityu.edu.hk/ef/doc/GRU/WPS/GRU%232018-025%20Ca'Zorzi.pdf (application/pdf)

Related works:
Journal Article: Exchange rate forecasting on a napkin (2020)
Working Paper: Exchange rate forecasting on a napkin (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:cth:wpaper:gru_2018_025

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