Nonlinear exchange rate predictability |
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Authors: | Carlos Felipe López-SuárezJosé Antonio Rodríguez-López |
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Institution: | a University of California, Berkeley, 508-1 Evans Hall 3880, Berkeley, CA 94720-3880, USA b University of California, 3151 Social Science Plaza, Irvine, CA 92697-5100, USA |
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Abstract: | We study whether the nonlinear behavior of the real exchange rate can help us account for the lack of predictability of the nominal exchange rate. We construct a smooth nonlinear error-correction model that allows us to test the hypotheses of nonlinear predictability of the nominal exchange rate and nonlinear behavior on the real exchange rate in the context of a fully specified cointegrated system. Using a panel of 19 countries and three numeraires, we find evidence of nonlinear predictability of the nominal exchange rate and of nonlinear mean reversion of the real exchange rate. Out-of-sample Theil’s U -statistics show a higher forecast precision of the nonlinear model than the one obtained with a random walk specification. Although the robustness of the out-of-sample results over different forecast windows is somewhat limited, we are able to obtain significant predictability gains—from a parsimonious structural model with PPP fundamentals—even at short-run horizons. |
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Keywords: | C53 F31 F47 |
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