Real exchange rate forecasting and ppp: this time the random walk loses

Michele Ca' Zorzi, Jakub Mućk and Michał Rubaszek

No 229, Globalization Institute Working Papers from Federal Reserve Bank of Dallas

Abstract: This paper brings four new insights into the Purchasing Power Parity (PPP) debate. First, we show that a half-life PPP (HL) model is able to forecast real exchange rates better than the random walk (RW) model at both short and long-term horizons. Second, we find that this result holds if the speed of adjustment to the sample mean is calibrated at reasonable values rather than estimated. Third, we find that it is preferable to calibrate, rather than to elicit as a prior, the parameter determining the speed of adjustment to PPP. Fourth, for most currencies in our sample, the HL model outperforms the RW also in terms of nominal effective exchange rate forecasting.

JEL-codes: C32 F31 F37 (search for similar items in EconPapers)
Pages: 27 pages
Date: 2015-03-01
New Economics Papers: this item is included in nep-for and nep-opm
Note: Published as: Ca' Zorzi, Michele, Jakub Muck and Michal Rubaszek (2015), "Real Exchange Rate Forecasting and PPP: This Time the Random Walk Loses," Open Economies Review 27 (3): 585-609.
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Citations: View citations in EconPapers (1)

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Related works:
Journal Article: Real Exchange Rate Forecasting and PPP: This Time the Random Walk Loses (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:feddgw:229

DOI: 10.24149/gwp229

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