Forecasting the Yen/U.S. Dollar exchange rate: Empirical evidence from a capital enhanced relative PPP-based model |
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Authors: | Axel Grossmann Marc W Simpson |
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Institution: | 1. Department of Accounting, Finance and Business Law, Radford University, Radford, VA, 24142, United States;2. Department of Finance, Northern Illinois University, DeKalb, IL 60115, United States |
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Abstract: | This study uses a relative purchasing power parity (PPP) model based on price indexes (consumer, CPI or traded-goods price indexes, TPI), interest rate differentials, and a linear forecasting technique to determine the horizon over which such a model outperforms a random walk in forecasting the Yen/U.S. Dollar exchange rates out-of-sample. The results improve if one adjusts a simple CPI-based PPP-model by interest rate differentials, while the best results are obtained using a TPI-based PPP-model. For example, the TPI-based model, adjusted by interest rate differentials, is able to statistically significantly outperform the pure random walk starting at forecast horizons of 1 month. |
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