An Evaluation of the Exchange Rate Forecasting Performance of the New Keynesian Model

Francis Vitek

MPRA Paper from University Library of Munich, Germany

Abstract: This paper evaluates the dynamic out of sample nominal exchange rate forecasting performance of the canonical New Keynesian model of a small open economy. A novel Bayesian procedure for jointly estimating the hyperparameters and trend components of a state space representation of an approximate linear panel unobserved components representation of this New Keynesian model, conditional on prior information concerning the values of hyperparameters and trend components, is developed and applied for this purpose. In agreement with the existing empirical literature, we find that nominal exchange rate movements are difficult to forecast, with a random walk generally dominating the canonical New Keynesian model of a small open economy in terms of predictive accuracy at all horizons. Nevertheless, we find empirical support for the common practice in the theoretical open economy macroeconomics literature of imposing deterministic equality restrictions on deep structural parameters across economies, both in sample and out of sample.

Keywords: Exchange rate forecasting; New Keynesian model; Small open economy (search for similar items in EconPapers)
JEL-codes: C11 C13 C33 F41 F47 (search for similar items in EconPapers)
Date: 2007-04-17
New Economics Papers: this item is included in nep-for and nep-ifn
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Journal Article: An Evaluation of the Exchange Rate Forecasting Performance of the New Keynesian Model (2007)
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:2945

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