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Exchange rate forecasting on a napkin

Michał Rubaszek () and Michele Ca' Zorzi

No 2151, Working Paper Series from European Central Bank

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. JEL Classification: C32, F31, F37, F41

Keywords: exchange rates; forecasting; mean reversion; panel data; Purchasing Power Parity (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-for and nep-mon
Date: 2018-05
Note: 343031
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