Real exchange rate forecasting: a calibrated half-life PPP model can beat the random walk

Michele Ca' Zorzi, Michał Rubaszek and Jakub Mućk

No 1576, Working Paper Series from European Central Bank

Abstract: This paper brings three new insights into the Purchasing Power Parity (PPP) debate. First, we show that a half-life PPP model is able to forecast real exchange rates (RER) better than the random walk (RW) model at both short and long-term horizons. Secondly, we find that this result holds only if the speed of adjustment to the sample mean is calibrated at reasonable values rather than estimated. Finally, we find that it is also preferable to calibrate, rather than to elicit as a prior, the parameter determining the speed of adjustment to PPP. JEL Classification: C32, F31, F37

Keywords: Exchange rate forecasting; half-life; purchasing power parity (search for similar items in EconPapers)
Date: 2013-08
New Economics Papers: this item is included in nep-cba, nep-for, nep-mon and nep-opm
Note: 343031
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https://www.ecb.europa.eu//pub/pdf/scpwps/ecbwp1576.pdf (application/pdf)

Related works:
Journal Article: Real Exchange Rate Forecasting and PPP: This Time the Random Walk Loses (2016)
Working Paper: Real exchange rate forecasting: a calibrated half-life PPP model can beat the random walk (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20131576

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