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Exchange Rate Equations Based on Interest Rate Rules: In-Sample and Out-of-Sample Performance (Faiz Kurallarina Dayali Doviz Kuru Denklemleri: Orneklem Ici ve Disi Performans)

Mahir Binici and Yin-Wong Cheung

Working Papers from Research and Monetary Policy Department, Central Bank of the Republic of Turkey

Abstract: Using exchange rate data on five currencies vis-à-vis the US dollar, this paper examines the insample and out-of-sample performance of exchange rate equations derived from alternative empirical and optimal interest rate rules. These rules could have either homogeneous or heterogeneous response coefficients. Our exercise shows that these exchange rate equations do not offer good in-sample explanatory power consistently across currencies and over time. The relative forecasting performance of these exchange rate equations tend to vary across currencies and over time and bears limited relationship with the relative in-sample performance. When the forecast performance is compared with a random walk model, these exchange rate equations offer no better performance under the usual MSFE criterion but are better when the ability of predicting the direction of change is considered.

Keywords: Taylor Rule; Exchange Rate Determination; Forecast Comparison; Mean Squared Forecast Error; Direction of Change (search for similar items in EconPapers)
JEL-codes: F31 E52 C52 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-for and nep-mon
Date: 2011
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