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Was It Real? The Exchange Rate‐Interest Differential Relation over the Modern Floating‐Rate Period
Abstract
This paper explores the relation between real exchange rates and real interest rate differentials for the United States, West Germany, Japan, and the United Kingdom. Contrary to theories based on the joint hypothesis that domestic prices are sticky and monetary dis turbances are predominant, the authors find little evidence of a stab le relationship between real interest rates and real exchange rates. They consider both in-sample and out-of-sample tests. One hypothesis which is consistent with their findings is that real disturbances may be a major source of exchange rate volatility. Copyright 1988 by American Finance Association.
... It is a stylized fact in the financial literature that forecasting exchange rate returns is highly challenging. The authors of [1,2] find that exchange rate models exhibit poor forecasting performance, especially compared with simple naive models such as the random walk (RW) and the driftless random walk (DRW): This is known as the Meese-Rogoff puzzle (see Appendix A for a detailed discussion). While there is still debate in the literature on whether exchange rates are predictable or not, it is a fact that the RW and the DRW are considered the most challenging benchmarks to outperform; as commented in [3], "The toughest benchmark is the random walk without drift". ...
... The predictive ability is not confined to the pandemic crisis but appears in many regimes. Table 4 reports our results for the ENC-t test, using Equation (2). In each panel, we report our results compared with the RW and the DRW considering BTC or ETH as the dominant cryptocurrency. ...
... Source: Authors' elaboration. Notes: Each entry reports the differences in correlations with the target variable between a forecast built using Equation (2) and the RW (historic average). The null hypothesis of equal correlations with the target variable is evaluated according to the correlation-based test proposed by [13]. ...
This paper tests the random walk hypothesis in the cryptocurrency market. Based on the well-known Meese–Rogoff puzzle, we evaluate whether cryptocurrency returns are predictable or not. For this purpose, we conduct in-sample and out-of-sample analyses to examine the forecasting power of our model built with autoregressive components and lagged returns of Bitcoin, compared with the random walk benchmark. To this end, we considered the 13 major cryptocurrencies between 2018 and 2022. Our results indicate that our models significantly outperform the random walk benchmark. In particular, cryptocurrencies tend to be far more persistent than regular exchange rates, and Bitcoin (BTC) seems to improve the predictive accuracy of our models for some cryptocurrencies. Furthermore, while the predictive performance is time varying, we find predictive ability in different regimes before and during the pandemic crisis. We think that these results are helpful to policymakers and investors because they open a new perspective on cryptocurrency investing strategies and regulations to improve financial stability.
... For instance, West (2006) [4] recognizes Wilson (1934) [29] as one of the earlier examples. Other famous works are Shiller (1989, 1990) [30,31] and Rogoff (1983, 1988) [6,7]. The main intuition in these empirical papers is the following: if a model is a reasonably good representation of the target variable, then this model should accurately forecast this target variable. ...
... Even though the random walk is very simple, it is difficult to outperform empirically. As famously noticed by Meese and Rogoff (1983) [6]: "We find that a random walk model would have predicted major-country exchange rates during the recent floating-rate period as well as any of our candidate models" [6], page 3. See Goyal and Welch (2008) [9], Rossi (2013) [32], and Meese and Rogoff (1988) [7] for more examples of how difficult it is to outperform a simple random walk with more complex nesting models. ...
... Even though the random walk is very simple, it is difficult to outperform empirically. As famously noticed by Meese and Rogoff (1983) [6]: "We find that a random walk model would have predicted major-country exchange rates during the recent floating-rate period as well as any of our candidate models" [6], page 3. See Goyal and Welch (2008) [9], Rossi (2013) [32], and Meese and Rogoff (1988) [7] for more examples of how difficult it is to outperform a simple random walk with more complex nesting models. ...
Are traditional tests of forecast evaluation well behaved when the competing (nested) model is biased? No, they are not. In this paper, we show analytically and via simulations that, under the null hypothesis of no encompassing, a bias in the nested model may severely distort the size properties of traditional out-of-sample tests in economic forecasting. Not surprisingly, these size distortions depend on the magnitude of the bias and the persistency of the additional predictors. We consider two different cases: (i) There is both in-sample and out-of-sample bias in the nested model. (ii) The bias is present exclusively out-of-sample. To address the former case, we propose a modified encompassing test (MENC-NEW) robust to a bias in the null model. Akin to the ENC-NEW statistic, the asymptotic distribution of our test is a functional of stochastic integrals of quadratic Brownian motions. While this distribution is not pivotal, we can easily estimate the nuisance parameters. To address the second case, we derive the new asymptotic distribution of the ENC-NEW, showing that critical values may differ remarkably. Our Monte Carlo simulations reveal that the MENC-NEW (and the ENC-NEW with adjusted critical values) is reasonably well-sized even when the ENC-NEW (with standard critical values) exhibits rejections rates three times higher than the nominal size.
... Among classical theoretical frameworks, it can be mentioned the interest rate differential (uncovered interest rate parity theory), the price levels differential (purchaising power parity theory) and the money supply (monetary theory). Concerning the choice of the variables, Meese and Rogoff (1988) tested classical predictors' forecasting accuracy against a random walk hypothesis. A similar approach was proposed by Mark (1995); Chinn and Meese (1995); Cheung et al. (2005Cheung et al. ( , 2019. ...
... The selection of an appropriate statistical model is an important point (see Rossi, 2013). Meese and Rogoff (1988) used the classical linear regression to obtain predictions (as well as Cheung et al., 2005;Molodtsova and Papell, 2009;Ferraro et al., 2015;Cheung et al., 2019), whereas Mark (1995) proposed long-run relationships among predictors and exchange rates with error correction models (ECM). Nevertheless, several papers (e.g., Kilian, 1999;Groen, 1999Groen, , 2002 showed an important drawback: the singleequation models without a co-integrating relation provide better out-of-sample forecasts for exchange rates. ...
... Overall, the puzzle is still not properly solved, and some questions remain open. Among the others, Meese and Rogoff (1988) themselves tried to explain the puzzle through sampling errors or model misspecification. By the way, it is not clear why some authors as Papell (2009) andFerraro et al. (2015) had evidence in favour of predictability with monthly data, while other authors as Cheung et al. (2005) and Cheung et al. (2019) obtained not favourable results with quarterly data. ...
Selecting an appropriate statistical model to forecast exchange rates is still today a relevant issue for policymakers and central bankers. The so-called Meese and Rogoff puzzle assesses that exchange rate fluctuations are unpredictable. In the literature, a lot of studies tried to solve the puzzle finding both alternative predictors (e.g., interest rates, price levels) and statistical models based on temporal aggregation. In this paper, we propose an approach based on mixed frequency models to overcome the lack of information caused by temporal aggregation. We show the effectiveness of our approach with an application to CAD/USD exchange rate predictions.
... Previous studies tried to solve the puzzle by finding new competing predictors and statistical models to forecast exchange rates better than the random walk model. Concerning the choice of the variables, Meese and Rogoff (1988) tested classical predictors' forecasting accuracy against the random walk hypothesis. A similar approach was proposed by Mark (1995); Chinn and Meese (1995); Cheung et al. (2005Cheung et al. ( , 2019. ...
... The puzzle is still not properly solved, and some questions remain open. For example, it is not clear why with monthly data some authors as Molodtsova and Papell and Ferraro et al. had Meese and Rogoff (1988) tried to explain the puzzle trough sampling errors or model misspecification. ...
... The β 3 coefficient on money differentials is usually restricted to 1, whereas β 2 is assumed to be negative since (y t − y * t ) < 0 implies a domestic currency depreciation with an increasing (ceteris paribus) foreign country output. Equation 4 has been defined flexible price version of the monetary model by Meese and Rogoff (1988). ...
Selecting an appropriate statistical model to forecast exchange rates is still today a relevant issue for policymakers and central bankers. The so-called Meese and Rogoff puzzle assesses that exchange rate fluctuations are unpredictable. In the literature, a lot of studies tried to solve the puzzle finding alternative predictors and statistical models based on temporal aggregation. In this paper, we propose an approach based on mixed frequency models to overcome the lack of information caused by temporal aggregation. We show the effectiveness of our approach in comparison with other proposed methods by performing CAD/USD exchange rate predictions.
... Against the popular belief and some accepted research work to confirm the association between the two (Benigno & Benigno, 2008;Cadenillas & Zapatero, 2000;Flood & Jeanne, 2005), most of the studies remain inconclusive between the two markets (Hnatkovska et al., 2013). The inconclusive nature of the relationship is not limited to developed economies (Meese, 1990;Meese & Rogofp, 1988) but to the developing nations as well (Calvo & Reinhart, 2002). Sheikh et al. (2020b) have also indicated that macroeconomic variability of interest rate influences money support. ...
... The similar findings are also reported by other prominent studies that IR does influence the ER (Benigno & Benigno, 2008;Cadenillas & Zapatero, 2000;Flood & Jeanne, 2005). However, there are studies which advocate inconsistent (Meese & Rogofp, 1988) and inconclusive association between the two (Hnatkovska et al., 2013). Despite all the evidence, we did not observe any study to have the VSE between them. ...
Literature is replete with evidence of market integration between crude oil, gold and interest rates (IR) with the exchange rate (ER) due to varied reasons. However, it is observed that the explored market integration is limited for the price and return volatilities. Bivariate GARCH models (BEKK-GARCH and DCC-GARCH) are used in this research to ascertain the conditional volatility association of gold, crude oil and yield (or IR) on the ER (the price of US$ in Indian rupee). The daily basis data from January, 2000 to December, 2022. Except for a few cases, it is found that the conditional covariance association of gold, crude oil and the yield on the ER are significant for both shocks and persistence. It confirms the economic theories of market connectivity. The results are as expected (from the previous literature) for conditional volatility, whereas findings regarding volatility spillover effects (VSE) and are surprising. The findings of the study imply the separation of price or returns integration from volatility integration. Co-movement of the prices has a limited impact; however, volatility integration has a larger and long-term impact. Therefore, the study endorses the views that gold, crude oil and IR markets can be treated separately from the ER markets with respect to the risk management of the ER. Studies involving volatility integration from these markets on the ER are not easily available. Therefore, there is a lack of knowledge about the nature of association with respect to the volatility among these markets, especially with respect to the ER market. The findings give key implication that government should consider these macroeconomic variables (gold-oil-interest) resilient against ER volatilities.
... A long-lasting puzzle, put forward by Meese and Rogoff (1983a, 1983band 1988, that fundamental based exchange rate models cannot outperform simple random walk forecast of no change, is still alive and well, as shown in a recent paper by Engel and Wu (2023). A prominence of this puzzle for standard open economy macro models is stressed by Itskhoki and Mukhin (2021) who placed it ahead of the other major puzzles in the field. ...
... Section 7 concludes. Meese and Rogoff (1983a, 1983band 1988 in their seminal papers advanced a puzzle that exchange rate fluctuations are unpredictable, implying its disconnection with economic fundamentals. More specifically they suggest that no change random walk exchange rate prediction is superior to the one base on economic models. ...
This paper finds that an out-of-sample forecast of a monetary model of exchange rate (MMER) in hyperinflation decisively beats a random walk one particularly at the most challenging one step ahead forecast, thus outperforming standard results previously obtained for low inflation episodes. The findings refer to the Serbian hyperinflation at daily frequency, and are robust with respect to various tests. Fast adjustment of the exchange rate to its fundamental value and the low, well below one discount factor found in the Serbian episode, as opposed to low-inflation ones, can account for divergent results in the respective inflation environments. The low discount factor appears in other hyperinflation episodes, while fast adjustment is due to the absence of nominal rigidities in hyperinflation thus both suggesting that reported findings for one episode might generalize.
... However, if it moves away from PPP, the trade will take place and force the exchange rate back to PPP, i.e., an adjustment process is started. However, this view of real exchange rate behaviour may be too optimistic when we remember the history of the most traded rate, the Deutsche mark versus the US dollar, which motivated us to apply bubble models on exchange rates (see, for instance, [5]). ...
... It is straightforward to include further exogenous variables to the basic model in Equation (2), and a natural candidate is the interest rate differential for a couple of reasons. First, the interest rate parity condition is of similar importance as PPP, and theoretical models indicate a relationship between interest rate differentials and the real exchange rate (see the discussion in [5] or, recently, [61]). Second, the recent empirical literature suggests that the interest rate differential plays an important role among fundamentals, see [28,29,62], and finds some explanatory power of the interest parity model for certain subperiods. ...
This study applies a Markov switching error correction model to describe the single most important real exchange rate (Deutsche mark versus US dollar) over the flexible exchange rates period from 1973 to 2004. We show an alternative way of modelling non-linear adjustment to the purchasing power parity (PPP) besides standard threshold models. The model merges the two possible sources of non-linearity by additionally allowing the probability of a mean-reverting regime to increase with the distance from PPP. The interest rate differential as an additional determinant of real exchange rate behaviour in a Markov switching framework is introduced in the model. The study finds that the real dollar exchange rate during the post-Bretton Woods era is well described by a Markov switching error correction model with (PPP) as long-run equilibrium. There is one mean reversion regime where PPP and the interest parity condition are valid. Contrary, the second regime is characterised by persistent mean aversion, where a regime switch does not become more likely with increasing distance from PPP. The unconditional half-life of shocks is about 1.5 years.
... Firstly, it is a standard in financial econometrics to compare the predictive accuracy of a given model A with a simple benchmark that usually is generated from a model B, which is nested in A (e.g., the 'no change forecast'). Some of the most influential empirical works, like Welch and Goyal (2008) [6] and Rogoff (1983,1988) [7,8], have shown that outperforming naïve models is an extremely difficult task. Secondly, comparisons within the context of nested models provide an easy and intuitive way to evaluate and identify the predictive content of a given variable X : suppose the only difference between two competing models is that one of them uses the predictor X , while the other one does not. ...
... In order to capture features from different economic/financial time series and different modeling situations that might induce a different behavior in the tests under evaluation, we considered three DGPs. The first DGP (DGP1) relates to the Meese-Rogoff puzzle and matches exchange rate data Rogoff (1983,1988) [7,8] found that, in terms of predictive accuracy, many exchange rate models perform poorly against a simple random walk). In this DGP, under the null hypothesis, the target variable is simply white noise. ...
In this paper, we present a new asymptotically normal test for out-of-sample evaluation in nested models. Our approach is a simple modification of a traditional encompassing test that is commonly known as Clark and West test (CW). The key point of our strategy is to introduce an independent random variable that prevents the traditional CW test from becoming degenerate under the null hypothesis of equal predictive ability. Using the approach developed by West (1996), we show that in our test, the impact of parameter estimation uncertainty vanishes asymptotically. Using a variety of Monte Carlo simulations in iterated multi-step-ahead forecasts, we evaluated our test and CW in terms of size and power. These simulations reveal that our approach is reasonably well-sized, even at long horizons when CW may present severe size distortions. In terms of power, results were mixed but CW has an edge over our approach. Finally, we illustrate the use of our test with an empirical application in the context of the commodity currencies literature.
... On the other hand, models that are based on real interest rate parity tend to increase the relative forecast errors. This empirical result is in accordance with evidence presented in Meese and Rogoff (1988) and, more recently in Alquist and Chinn (2008), where the predictive ability of interest rates does not seem to beat random walk. ...
... Početne studije koje su se bavile istraživanjem validnosti PPP hipoteze su u prošlosti bile bazirane na korišćenju konvencionalnih, odnosno tradicionalnih testova kao što su ADF (Dickey & Fuller, 1979 & Rogoff, 1988;Edison & Fisher, 1991). Wu (1996) je smatrao da prisutna slabost ovih testova može biti prevaziđena upotrebom panelnih testova i produženjem vremenskog obuhvata analize. ...
Ova studija usmerena je na istraživanje validnosti pariteta kupovne moći u dugom roku u Srbiji. Period ispitivanja je od početka 2012. do završetka 2021. godine na bazi mesečnih podataka o realnom efektivnom deviznom kursu, nominalnom deviznom kursu, inostranom i domaćem nivou cena. Primenjena su dva ekstenzivna, diversifikovana i sveobuhvatna postupka analize: testiranje kointegracije i testiranje jediničnog korena. Nakon izvedenih analiza i celokupnog sagledavanja dobijenih rezultata nije potvrđena validnost pariteta kupovne moći u posmatranom periodu sa visokim stepenom pouzdanosti. Dobijeni rezultati upućuju na mogućnost daljih istraživanja alternativnim metodama, kako bi se utvrdilo da li je režim deviznog kursa adekvatno determinisan da sledi dalji pravac razvoja srpske ekonomjie.
... Using Eq. (1), Meese and Rogoff (1988) conducted a study to predict out-of-sample real exchange rates by utilizing real interest rate differentials. Their findings revealed that this approach outperformed a random walk model. ...
The foreign exchange markets, renowned as the largest financial markets globally, also stand out as one of the most intricate due to their substantial volatility, nonlinearity, and irregular nature. Owing to these challenging attributes, various research endeavors have been undertaken to effectively forecast future currency prices in foreign exchange with precision. The studies performed have built models utilizing statistical methods, being the Monte Carlo algorithm the most popular. In this study, we propose to apply Auxiliary-Field Quantum Monte Carlo to increase the precision of the FOREX markets models from different sample sizes to test simulations in different stress contexts. Our findings reveal that the implementation of Auxiliary-Field Quantum Monte Carlo significantly enhances the accuracy of these models, as evidenced by the minimal error and consistent estimations achieved in the FOREX market. This research holds valuable implications for both the general public and financial institutions, empowering them to effectively anticipate significant volatility in exchange rate trends and the associated risks. These insights provide crucial guidance for future decision-making processes.
... (Engel 1986)menunjukkan adanya korelasi negatif antara suku bunga dan nilai tukar. Serupa dengan (Meese and Rogoff 1988) menganggap bahwa hubungan yang stabil antara tingkat bunga riil dan nilai tukar riil tidak ada, volatilitas nilai tukar riil paling utama dipengaruhi oleh shock. (Hoffman and MacDonald 2009) menemukan bahwa terdapat pengaruh suku bunga terhadap nilai tukar namun bersifat sementara, dan perubahan awal nilai tukar diimbangi melalui harga relatif. ...
Nilai tukar merupakan persoalan yang kompleks dengan banyak dimensi yang dihadapi seluruh negara. Nilai tukar yang stabil menjadi indikator pertumubuhan ekonomi. Nilai tukar suatu negara harus dijaga tingkat kestabilannya karena jika nilai mata uang mengalami pelemahan dalam jangka yang lama maka akan mempengaruhi sisi impor yang nantinya akan mempengaruhi pertmubuhan ekonomi pada negara tersebut. Otoritas moneter memegang peranan penting dalam menstabilkan nilai mata uang. Penelitian ini mencoba untuk melihat determinan nilai tukar dengan menggunakan variabel inflasi, suku bunga, dan cadangan devisa menggunakan data sekunder dan teknik analisis regresi linear berganda. Adapun hasil yang diperoleh dari penelitian ini adalah variabel inflasi mempunyai hubungan negatif dan signifikan terhadap nilai tukar, variabel suku bunga dan cadangan devisa mempunyai pengaruh positif dan signifikan terhadap nilai tukar.
... However, similar conclusions are not established in every case of finding the rationality of PPP theory in the long run. While for example, Meese and Rogoff (1988), Kim (1990), Abuaf and Jorian (1990), Becketti, Hakkio, and Joines (1995), Glen (1992), and Pippenger (1993) find confirmation of the theory in the long run, whereas Ahking (1997) and Cooper (1994) find the opposite result. However, the studies by Baillie and Patrick (1989), Chowdhury and Sdogati (1993), Corbae and Ouliaris (1988), Flynn and Boucher (1993), and Beng (1991) find proof in support of rejecting the hypothesis. ...
Purpose: This study aims to empirically assess the rationality of Purchasing Power Parity (PPP) theory in Developing-8 (D-8) countries. For this purpose, the data of PPP, Consumer Price Index (CPI), and Wholesale Price Index (WPI) were used from 1990 to 2015, with annual frequency. Methodology: This paper attempted to set up the long-run association between the nominal exchange rate and relative prices as opposed to old investigations. This study applies the ADF, PP, and the recently developed KPSS test to test data stationarity, followed by a cointegration test, granger casualty test, and vector error correction model. Findings: Time-series properties of this study specify that the real exchange rates are stationary for sample countries, indicating PPP holds in these countries, whereas Cointegration results demonstrate that a strong cointegrating relationship exists among the variables of Bangladesh and Turkey only. Practical Implications: The findings of the study have some policy implications, which suggest some recommendations for bilateral trade among these countries. Originality: Findings of the paper suggest that the structure of these developing eight (D-8) countries tends to be less diverse, and fewer economic changes occur than in developed countries. Limitations: Findings of this paper can vary on a different set of databases depending on the changing pattern of CPI and WPI.
... Conversely, Meese and Rogoff (1988), Giovannini (1988), Engel and Ng (1993), Engel and Roger (1995) concluded that the deviation of prices is random and persistently autorelated with exchange rate movements implying that the LOP may not hold. However, Adrangi, Allender and Raffiee (2011), as well as Madesha, Chidoko and Zivanomoyo (2013) confirm that there are intra-flows between exchange rate and inflation. ...
... However, in the modern era, the global turnover in foreign exchange is much higher than can be explained solely by international trade. Meese & Rogoff, (1983a, 1983b, 1988 published a series of papers in which they questioned the credibility of these monetary exchange rate models, which were subsequently withdrawn from circulation. Their empirical findings show that the models' forecasts of future nominal and real exchange rates were not as accurate as a naive random walk in predicting future nominal and real exchange rates Because the random walk model does not make use of any fundamental information, the outcome was out of the ordinary. ...
... A number of empirical studies have thus been conducted to seek solid evidence supporting stable relationships between major macroeconomic variables and nominal floating exchange rates. Evidence revealed by wide-ranging quantitative studies in the academic literature has been mixed; see Meese and Rogoff (1988), Edison and Pauls (1993), Issac and De Mel (2001), Sarno (2005), and Kurita (2007) as examples for various empirical results in the literature. These difficulties have also led to theoretical and empirical research aimed at the explanation of observed deviations in exchange rates from macroeconomic fundamentals; see Engel and West (2005), Bacchetta and Van Wincoop (2013), and Balke et al. (2013), Hunter and Ali (2014), inter alia. ...
The purpose of this study is to establish a theory‐consistent econometric model for the Canadian–US dollar exchange rate over the post‐Bretton Woods floating period, 1975–2021. In pursuing the objective, this paper reviews Canadian history in the context of major political events, bearing in mind the importance of oil for the Canadian economy, and it also assigns importance to allowing for structural breaks in the early 1980s and 2000s observed in the data. The overall empirical results support the fundamental‐based view of the long‐run exchange rate determination. This study also examines long‐run and short‐run influences of oil prices on the exchange rate dynamics because of the anticipated significant role for the US–Canada dyad.
... However, in the modern era, the global turnover in foreign exchange is much higher than can be explained solely by international trade. Meese & Rogoff, (1983a, 1983b, 1988 published a series of papers in which they questioned the credibility of these monetary exchange rate models, which were subsequently withdrawn from circulation. Their empirical findings show that the models' forecasts of future nominal and real exchange rates were not as accurate as a naive random walk in predicting future nominal and real exchange rates Because the random walk model does not make use of any fundamental information, the outcome was out of the ordinary. ...
The goal of this study is to forecast the Malaysian Ringgit exchange rate against the US Dollar using individual and combined models. There are three univariate models and one multivariate model among the four individual models. ARIMA, Nave, and Exponential Smoothing are the three univariate models, and NARDL is the multivariate model. The monthly data has been taken over the period from held back for the in-sample forecasting. The findings show that the NARDL plays an important role in exchange rate forecasting and outperforms all individual and combined by the least MAPE value of 0.2066. It is also clear that the var-cor combination of NARDL and Nave outperforms three individual and other combined models with a MAPE value of 0.352. It supports Poon and Granger's (2003) argument that combining models can produce better forecasting than individual models. The findings are useful for policymakers, FOREX markets, investors, traders, tourists, and hedgers in adjusting their policies accordingly.
... Levich, 1978), c) aplikuji portfoliový přístup v oblasti kurzu (Branson, 1976;Mussa, 1984a Mishkin, 1984. Samostatnou skupinu d) pak tvoří modely založené na koncepci nominálního nebo reálného úrokového diferenciálu (Frankel, 1979;Meese a Rogoff, 1988a Hakkio, 1986. Z hlediska teorie měnového kurzu lze rovnici nekryté úrokové parity "aplikovat" dvojím způsobem. ...
Heteroskedasticity is a common feature in empirical time series analysis, and in this paper, we consider the effects of heteroskedasticity on statistical tests for equal forecast accuracy. In such a context, we propose two new Diebold–Mariano‐type tests for equal accuracy that employ nonparametric estimation of the loss differential variance function. We demonstrate that these tests have the potential to achieve power improvements relative to the original Diebold–Mariano test in the presence of heteroskedasticity, for a quite general class of loss differential series. The size validity and potential power superiority of our new tests are studied theoretically and in Monte Carlo simulations. We apply our new tests to competing forecasts of changes in the dollar/sterling exchange rate and find the new tests provide greater evidence of differences in forecast accuracy than the original Diebold–Mariano test, illustrating the value of these new procedures for practitioners.
The main aim of this study is to figure out whether the PPP hold or not in Cambodia? This research thoroughly takes into account major controversies which many researchers cogitate to be the cause of PPP breakdown. The aforementioned controversies are the using of the bilateral exchange rate which consists of short time-series or the using of multilateral or real effective exchange rate (REER) constructed by the fixed trade weight, the implementing of only the most popular unit root or stationary tests, such as ADF and PP tests to test for PPP. Thereof, this shortcoming is fulfilled through the implementing of another alternative stationary test known as the KPSS test on the monthly constructed REER from January 1995 to July 2019. The total data points or months of 295 is constructed using time-varying trade weights from 1995 to 2019 of Cambodia. After attempting to deal with the controversies thereto, the empirical result indicates that the PPP theory holds in Cambodia based on the result of the ADF test which is modeled with constant and trend. The test result indicates that the REER of Cambodia has a mean reverting process. Keywords: PPP, REER, Time-Varying Trade Weights, Unit Root Test.
This paper investigates the real interest parity hypothesis by testing stationarity of real interest rate differentials for 52 countries with respect to the USA. Taking account of the fact that both asymmetric adjustment and gradual temporary breaks may better characterize the dynamics of real interest rate differentials, we propose a new test that allows for two temporary shifts together with asymmetric adjustment towards the equilibrium. We employ the newly proposed test procedure along with the conventional ADF test as well as nonlinear KSS and OSH tests to examine stationarity of real interest rate differentials. Among the main results, we find that the newly proposed unit root test procedure highly outperforms the existing unit root tests in terms of rejecting the null hypothesis of unit root. Our results suggest that real interest rate differentials can be characterized by a stationary process with asymmetric adjustment around gradual and temporary shifts of mean.
El propósito de este artículo es evaluar la capacidad predictiva que tiene la herramienta de Google Trends para predecir los tipos de cambio de los países que componen el mercado MILA: Chile, Perú, Colombia y México. El argumento económico y financiero detrás de esta investigación es que la frecuencia de búsqueda que entrega Google Trends es un proxy de las expectativas que tienen los agentes en el mercado sobre el rendimiento en la economía. Se utiliza el Diccionario de Harvard para recono-cer palabras con connotación positiva y negativa, respecto al estado de la economía de cada país. Se realizan análisis dentro y fuera de la muestra para evaluar la capacidad predictiva de Google Trends. Además, existe una reciente literatura que utiliza esta herramienta para pronósticos de tipo de cambio en los países de Japón y Estados Unidos, pero poco se conoce en economías latinoamericanas de países MILA. Consistente con evidencia previa, los resultados de predictibilidad son inestables y poco robustos. Este estudio es importante para inversionistas, portfolio manager o agentes que deben ges-tionar el riesgo del tipo de cambio.
Merkez bankaları para politikası araçlarını kullanarak nihai hedefleri olan fiyat istikrarını sağlamaya çalışırlar. Politika faiz oranları, merkez bankaları tarafından kullanılan en önemli para politikası araçlarının başında gelmektedir. Bu çalışmanın amacı, ekonometrik bir teknik olan Olay Çalışması Metodolojisi (OÇM) kullanılarak Türkiye Cumhuriyet Merkez Bankası (TCMB) Para Politikası Kurulunun (PPK) 24.09.2021 tarihinde yapılan politika faiz oranındaki indirimin TL/ABD Doları kuru (DK) üzerindeki etkisini incelemektir. Faiz değişikliğine gidilen tarihin seçimine dair esaslar veri ve metodoloji bölümünde açıklanmıştır. Analiz sonuçlarına göre TCMB PPK faiz değişiklik kararının DK üzerinde etkisi olmadığı tespit edilmiştir.
We propose a naïve model averaging (NMA) method that averages the OLS out-of-sample forecasts and the historical means and produces mostly positive out-of-sample R2s for the variables significant in sample in forecasting market returns. Surprisingly, more sophisticated weighting schemes that combine the predictive variable and historical mean do not consistently perform better. With unstable economic relations and a limited sample size, sophisticated methods may lead to overfitting or be subject to more estimation errors. In such situations, our simple methods may work better. Model misspecification, rather than declining return predictability, likely explains the predictive performance of the NMA method. (JEL G12, G11)
Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.
This paper proposes a model-free test for the strict stationarity of a potentially vector-valued time series using the discrete Fourier transform (DFT) approach. We show that the DFT of a residual process based on the empirical characteristic function weakly converges to a zero spectrum in the frequency domain for a strictly stationary time series and a nonzero spectrum otherwise. The proposed test is powerful against various types of nonstationarity including deterministic trends and smooth or abrupt structural changes. It does not require smoothed nonparametric estimation and, thus, can detect the Pitman sequence of local alternatives at the parametric rate $T^{-1/2}$ , faster than all existing nonparametric tests. We also design a class of derivative tests based on the characteristic function to test the stationarity in various moments. Monte Carlo studies demonstrate that our test has reasonarble size and excellent power. Our empirical application of exchange rates strongly suggests that both nominal and real exchange rate returns are nonstationary, which the augmented Dickey–Fuller and Kwiatkowski–Phillips–Schmidt–Shin tests may overlook.
A R T I C L E I N F O Keywords: Prophet model ICEEMDAN Multi-model optimization error correction DM test Model confidence set trimming A B S T R A C T Nonferrous metals are the basic materials and key strategic reserve resources for national economic development. The fluctuation of metal prices seriously affects the development of modern industry and the global economy. Therefore, accurate and stable nonferrous metal price prediction is very important and meaningful. In this paper, a relatively novel prediction system is proposed to predict the price of metals. The hybrid model of the Prophet model, ICEEMDAN and multi-model optimization error correction is applied to predict the prices of the metals zinc, aluminum, copper and gold. The Prophet model can predict the data more concisely by combining the research background and statistical knowledge, but there are also some nonlinear residual sequences in the prediction. Therefore, ICEEMDAN is used to decompose the residual sequence, and ARIMA, ELMAN, BPNN, LSTM and NAR are applied to predict the decomposed subsequences. Then, the optimal prediction results in each subsequence are selected to add the residual prediction value. Finally, the prediction value of the original price is obtained by adding the Prophet model and the residual prediction value. The price series of four metals from the London Metal Exchange and Investing are selected as the research object. Through two groups of experiments, the proposed model is compared with six single models and six hybrid models. At the same time, to further verify the performance and the reliability of the proposed model, DM detection and model confidence set trimming are used. Through the evaluation index and the performance test of the model, the proposed model's superiority and reliability in metal price prediction are effectively proven.
In this paper we use a Threshold AutoRegressive (TAR) model to capture the nonlinear dynamics of monthly real effective exchange rate data for the G7 countries. The novelty of our approach relates to the use of the real interest differential as the switching variable. This choice allows us to consider jointly the nonlinearity and nonstationarity issues using recent advances in asymptotic theory. We find that the null of linearity is easily rejected against the nonlinear model for all currencies considered. Further, for five out of the seven countries, where the null of unit root is rejected, we report evidence of quite rapid mean reversion.
This paper investigates whether currency risk is priced differently in the different sectors (industrial, financial, and basic materials) of equity markets in a sample of developed United States of America (USA) and developing economies (Brazil, India, Poland, and South Africa). The paper makes use of the following techniques: (i) Univariate Autoregressive Fractionally Integrated Moving Average and Exponential General Autoregressive Conditional Heteroskedastic (ARFIMA-EGARCH), (ii) the Markov Switching method (MS), and (iii) the Canonical Vine Copulas (C-Vine) techniques. Using a sample of daily data made of the foreign exchange rate against the domestic currency and equity market sectors; our findings show that there is an asymmetry effect between equity markets and the foreign exchange rate: there is a heterogeneous, strong, and positive dependence between the two. Higher equity prices are associated with depreciation of local currencies, according to US dollar (USD) exchange rates. In addition, we find that the selected emerging economies are pricing a positive and considerable currency risk. The pricing of currency risk has a varied effect in both regimes representing the states of the economy. In fact, when currency risk pricing has a beneficial impact on certain sectors of the economy, investors predict better returns.
p>In an introductory chapter we collect together some recent results on the representation, estimation and testing of cointegrated I(2) systems. In particular, we focus on some recent developments such as tests on the cointegration parameters of Kongsted [1998, 2000] and examining in detail the influence of deterministic components in the I(2) model as well as providing an overview of the maximum likelihood procedure detailed in Johansen [1997].
The first empirical chapter provides evidence on a range of issues concerning the correct treatment of I(2) variables when modelling UK money demand. We show that by including the dummy variables in Hendry and Mizon [1993] the conclusions on the number of cointegrating relations and I(2) trends arrived at in Johansen [1992], Paruolo [1996] and Rahbek et al. [1999] are unchanged. However, we also show that the real transformation employed in Hendry and Mizon [1993] and Hendry and Doornik [1994] is inadequate to reduce the model to I(1) space and, moreover, that the common result of weak exogeneity with respect to the cointegration parameters may also rest upon this improper restriction. Instead, we show that by correctly accounting for the time series properties of the data a congruent equilibrium correction model can be obtained that incorporates the long run information in the model. Furthermore, we show that this model provides superior forecasting performance when compared to simple time series models such as a vector autoregression in double differences.
The second empirical chapter provides the first empirical examination of the monetary exchange rate model that allows for the presence of I(2) variables in the data. First, for the dollar-sterling exchange rate over the modern float we find strong support for the existence of cointegration among the variables in the monetary model. In addition, by testing for the number of I(1) and I(2) trends we find evidence for I(2) variables in the data. As a consequence the stationary cointegrating relation found corresponds to a polynomial relation where the linear combination of the differences of the variables are required in order to provide a stationary relationship.</p
We analyze the impact of the Covid-19 pandemic on emerging market real exchange rates using a Behavioral Equilibrium Exchange Rate approach augmented by pandemic variables. We show that behavioral factors related to Covid-19 played a significant role in explaining the behavior of emerging market real exchange rates during the first wave of the pandemic. The real exchange rates were driven by the number of new Covid-19 deaths rather than by the number of new infections. These results are robust for different country samples.
Among all the important targets that a country wants to realize from an economic perspective, i.e. reducing current account deficit, reduction in the inflation soaring, struggle with unemployment, reduction in the debt burden of the public/fiscal deficit. The main target which underlying all these desires is economic stability. For economic stability, the exchange rate plays an important role, due to little fluctuation in exchange rates, exports, imports, domestic interest rates, debts and employment level gets affected. The primary objective of this study is to empirically examine the long-run relationship between the relative productivity differential (Tradable and Non-tradable goods sector) and Real exchange rate movements with the help of the Balassa-Samuelson (BS) effect. This study uses industry-wise disaggregation provided by KLEMS database to investigate whether the more segregations of industries into non-tradable and tradable goods sector matters for real exchange rate movements across countries. This study uses two groups, BRICS countries and the Indian economy for the period of 1991-2018 and 1981-2018 respectively. With the help of panel cointegration tests proposed by Pedroni and Kao, this paper examined the long run association between the real exchange rate and productivity differential. Contrary to the findings of available in the literature, the study does not find any evidence of BS effect for BRICS nations, but finds the evidence of BS effect for India.
The value of a country's currency is often considered as the most important price in the economy. Exchange‐rate changes can significantly affect the profitability of exporters, the prices paid by consumers, as well as complicating the comparison of the economies of different countries. In this article, we illustrate the workings of the purchasing power parity (PPP) and demonstrate its practical use with cross‐country data covering the 50 years since the collapse of the Bretton Woods monetary system. We find that despite the prolonged gyrations of currency values and the multitude of trade barriers, the forces of arbitrage and resource re‐allocation are sufficient to overcome many of these distortions in the longer term. We also provide a broad survey of other prominent themes, both extant and emerging, in international economics that highlight the importance of the relationship between exchange rates and prices.
The paper revisits the purchasing power parity (PPP) puzzle and investigates potential sources of rigidity in the real exchange rate convergence. We propose two hypotheses on the slow convergence estimates in previous studies, and re-estimate the convergence rates to test the hypotheses. First, the slow convergence estimation is potentially from the forex market intervention by the central banks which claim to freely float their exchanges. Second, the real exchange rates may not show any convergence if they are already converged and within the “region of inaction.” We identify the regions of inaction (1) by creating bands around averages of real exchange rates, assuming that the PPP forms around the long-run averages, and (2) by using a Bayesian Dynamic Linear Model (DLM), assuming that real exchange rates converge to the different levels over time. We use a standard fixed effect estimation as well as a mean group panel estimation to handle aggregation biases in standard panel estimation. The results confirm the propositions and make the puzzle less puzzling; we find approximately 30%–65% shorter half-life estimates than the standard fixed effects estimates in previous studies.
This paper examines empirical tests of purchasing power parity theory (PPP) from a methodological perspective. In particular the issue of whether economists have seriously attempted to falsify the theory is addressed. While the results of econometric tests have been largely negative, this has not led to the falsification of PPP or its rejection by economists. The main reason for this is that economists have in practice adopted a methodology resembling the older inexact method a priori, revived recently by Hausman. The intensive econometric work into PPP may thus be construed as the attempt to find satisfactory empirical models of the theory or testing for the limitations and range of application of the underlying theory, rather than seriously testing the theory with a view to falsification. The nature and extent of the progress made in this field is also questioned.
The primary purpose of the paper is to enable deeper insight into the measurement of economic forecast accuracy. The paper employs the systematic literature review as its research methodology. It is also the first systematic review of the measures of economic forecast accuracy conducted in scientific research. The citation-based analysis confirms the growing interest of researchers in the topic. Research on economic forecast accuracy is continuously developing and improving with the adoption of new methodological approaches. An overview of the limits and advantages of the methods used to assess forecast accuracy not only facilitate the selection and application of appropriate measures in future analytical works but also contribute to a better interpretation of the results. In addition to the presented advantages and disadvantages, the chronological presentation of methodological development (measures, tests, and strategies) provides an insight into the possibilities of further upgrading and improving the methodological framework. The review of empirical findings, in addition to insight into existing results, indicates insufficiently researched topics. All in all, the results presented in this paper can be a good basis and inspiration for creating new scientific contributions in future works.
Purpose
Crude oil, gold and interest rates are some of the key indicators of the health of domestic as well as global economy. The purpose of the study is to find the shock volatility and price volatility effects of gold and crude oil market on interest rates in India.
Design/methodology/approach
This study finds the mutual and directional association of the volatility of gold, crude oil and interest rates in India. The bi-variate GARCH models (Diagonal VEC GARCH and BEKK GARCH) are applied on the sample data of gold price, crude oil price and yield (interest rate) gathered from November 30, 2015 to November 16, 2020 (weekly basis) to investigate the volatility association including the volatility spillover effect in the three markets.
Findings
The main findings of the study focus on having a long-term conditional correlation between gold and interest rates, but there is no evidence of volatility spillover from gold and crude oil on the interest rates. The findings of the study are of great importance especially to the policymakers, as they state that the fluctuations in prices of gold and crude oil do not adversely impact the interest rates in India. Therefore, the fluctuations in prices of gold and crude may generally impact the economy, but it has nothing to do with interest rate in particular. This implies that domestic and foreign investments in the country will not be affected by gold and crude oil that are largely driven by interest rates in the country.
Practical implications
Gold and crude oil are two very important commodities that have their importance not only for domestic affairs but also for international business. They veritably influence the economy including forex exchange for any nation. In addition to this, the researchers believe the findings will provide insights to policymakers, stakeholders and investors.
Originality/value
Gold and crude oil undoubtedly influence the exchange rates but their impact on the interest rates in an economy is not definite and remains ambiguous owing to the mixed findings of the studies. The lack of studies related to the impact of gold and crude oil on the interest rates, despite them being essentials for the health of any economy is the main motivation of this study. This study is novel as it investigates the volatility impact of crude oil and gold on interest rates and contributes to the existing literature with its findings.
The exchange rate is the price of the currency from one country against the currency of another country so that the exchange rate can be valued or expressed in the currency of another country. The exchange rate movement is a serious concern by the government as the monetary authority to supervise and control it. The exchange rate system is determined by the market mechanism because the demand and supply of the foreign currency are on the financial market, making its movements more difficult to predict. In this study, the prediction of the exchange rate of the United States Dollar (USD) to the Indonesian Rupiah (IDR) is modeled using the nonlinear Schrödinger equation (NLSE) calculated by the fourth-order Runge-Kutta. The parameters contained in the NLSE can be analogous to economic variables which assume that these variables affect the exchange rate. These economic variables include the inflation rates, the interest rate, the rates of return, and the Gross Domestic Product (GDP). The NLSE model is applied to predict the (IDR/USD) exchange rate. The NLSE model is calculated using the numerical method of the fourth-order Runge-Kutta, then the prediction results of the (IDR/USD) exchange rate are compared with the actual data from the (IDR/USD) exchange rate resulting in an error percentage of under 2.5% per month. The prediction results based on the Mean Absolute Percentage Error (MAPE) value calculation is 0.48%. The MAPE value shows that the smaller the MAPE value, the prediction results of the exchange rate will be closer to the data from the actual exchange rate.
We use the Banco de la República expectations survey of external economic analysts to study whether fixed-event individual forecasts of inflation and exchange rate are updated efficiently when new information becomes available. To this end, we test for weak-form and strong-form efficiency. The novel aspects of this paper are that we relax the individual homogeneity assumption, and consider a forecasters’ information set that contains a large number of empirically relevant variables. We address model selection using two of the most popular methods available in the penalised regression literature, and a new form of multiple testing. Our results show that more than half of the analysts’ revisions are independent of one another (weakly efficient). Also, conditional on passing weak efficiency, we find that analysts use past values of inflation and exchange rate changes to revise their forecasts and a broader array of variables during periods of market instability.
The three essays included in the thesis examine the issue of nonlinearity in exchange rates from different perspectives. In the first essay the issue of model selection in financial markets is examined and it is demonstrated that in order to evaluate models of nonlinearity in financial asset returns the Quadratic Loss function is not the best one to use. A new criterion based on the Exponential Utility loss function is proposed and it is argued that this loss function is much more closely related to the decision rules used by financial market participants. In the second essay the new criterion developed in the first essay is used to evaluate the two state Markov Switching model for exchange rate returns measured at a monthly frequency. It is found that with the new criterion it is not possible to reject the null of no difference between the Random Walk and the Markov Switching model for the British Pound, the Japanese Yen and the Deutsche Mark. The importance of using "appropriate" loss functions is also demonstrated in this essay. In the third essay the dynamics of financial market volatility are examined for exchange rates, interest rates and the S&P 500 index. For all these assets it is found that the standard GARCH(1,1), EGARCH(1,1) and Stochastic Variance with AR(1) variance specification are not able to capture the rich volatility dynamics present in the data.
Exchange rate instability has become a key concern within economic policy circles ever since the 1973 breakdown of Bretton Woods agreement; after 47 years, central bankers realize the deleterious effect of exchange rate on the economy in the 12 selected OIC member countries we studied. The aim of this paper is to report the findings on a proposed measure of currency instability, namely the relative volatility, to test it with data relating to 12 OIC member Muslim-majority economies using more than 28 years data. We find that relative volatility is an effective measure for tracking currency instability and exchange rate targeting could be enhanced by including policy bands as well as recommended actions for each movement outside the policy band. Further, relative volatility is significantly correlated with monetary factors suggested by strong theories that drive the exchange rate equilibrium.
Let n observations Y 1, Y 2, ···, Y n be generated by the model Y t = pY t−1 + e t , where Y 0 is a fixed constant and {e t } t-1 n is a sequence of independent normal random variables with mean 0 and variance σ2. Properties of the regression estimator of p are obtained under the assumption that p = ±1. Representations for the limit distributions of the estimator of p and of the regression t test are derived. The estimator of p and the regression t test furnish methods of testing the hypothesis that p = 1.
The growth in the empirical literature on testing for divergent (in mean) speculative bubbles indicates that existing theoretical arguments for ruling out such price paths are not sufficiently compelling. Here we strengthen the case for ruling out explosive or implosive bubbles a priori by filling in two gaps. First, we demonstrate why divergent stochastic bubbles arising from purely extrinsic uncertainty [as in Blanchard (1979)] cannot be equilibria in a monetary optimizing model. Second, we show why existing arguments for ruling out implosive price bubbles are insufficient in some cases, and we provide stronger arguments.
Knife-edge stability is a common property of dynamic monetary models assuming perfect foresight or rational expectations. These models can be closed with the assumption that the economy's equilibrium lies on the unique convergent path (the saddlepath). While this empirically plausible assumption yields sensible results, aggregative models are not specified in sufficient detail to allow one to prove that the saddlepath is the unique equilibrium path. Brock (1974, 1975) and Brock and Scheinkman (1980) have advanced models in which individual preferences are more fully specified and in which, under certain conditions, the uniqueness and stability of equilibrium can be rigorously demonstrated. This paper shows that these uniqueness conditions are economically unreasonable. Therefore, the question these maximizing models address remains unresolved.
This paper studies the random walk in a general time series setting that allows for weakly dependent and heterogeneously distributed innovations. It is shown that simple least squares regression consistently estimates a unit root under very general conditions in spite of the presence of autocorrelated errors. The limiting distribution of the standardized estimator and the associated regression t statistic are found using functional central limit theory. New tests of the random walk hypothesis are developed which permit a wide class of dependent and heterogeneous innovation sequences. A new limiting distribution theory is constructed based on the concept of continuous data recording. This theory, together with an asymptotic expansion that is developed in the paper for the unit root case, explain many of the interesting experimental results recently reported in Evans and Savin (1981, 1984). Copyright 1987 by The Econometric Society.
The subject of time series is of considerable interest, especially among researchers in econometrics, engineering, and the natural sciences. As part of the prestigious Wiley Series in Probability and Statistics, this book provides a lucid introduction to the field and, in this new Second Edition, covers the important advances of recent years, including nonstationary models, nonlinear estimation, multivariate models, state space representations, and empirical model identification. New sections have also been added on the Wold decomposition, partial autocorrelation, long memory processes, and the Kalman filter. Major topics include: * Moving average and autoregressive processes * Introduction to Fourier analysis * Spectral theory and filtering * Large sample theory * Estimation of the mean and autocorrelations * Estimation of the spectrum * Parameter estimation * Regression, trend, and seasonality * Unit root and explosive time series To accommodate a wide variety of readers, review material, especially on elementary results in Fourier analysis, large sample statistics, and difference equations, has been included.
The paper develops a two-step estimator for use in rational-expectations models with autocorrelated residuals and predetermined, but not strictly exogenous, instruments. The estimator extends the applicability of McCallum's (1976) error-in-variablesapproach to estimating such models, and is asymptotically efficient in a class of intrumental-variables estimators. As an application we use instrumental-variables techniques to estimate Taylor's (1979) rational-expectations macroeconomic model of the United States.
This study compares the out-of-sample forecasting accuracy of various structural and time series exchange rate models. We find that a random walk model performs as well as any estimated model at one to twelve month horizons for the dollar/pound, dollar/mark, dollar/yen and trade-weighted dollar exchange rates. The candidate structural models include the flexible-price (Frenkel-Bilson) and sticky-price (Dornbusch-Frankel) monetary models, and a sticky-price model which incorporates the current account (Hooper-Morton). The structural models perform poorly despite the fact that we base their forecasts on actual realized values of future explanatory variables.
This paper reformulates the monetary approach after ascertaining that a money demand function with a partial adjustment mechanism had more empirical support than a money demand function which assumed instantaneous stock adjustment. The resulting exchange rate equation is estimated by two rational expectations techniques. The parameter estimates are reasonable, and are robust to the estimation technique used, to different specifications of the driving processes, and to changes in the estimation period. The structural model outperforms the random walk model and its own unconstrained equivalent, a pure time series equation, in outof-sample forecasts.
This paper is an analytic comment on two chapters of the Economic Report of the President for 2006. Chapter One deals with the economy in 2005 and the outlook for the future. The chapter provides a detailed analysis of the expansion in 2005 but not an explanation of why the expansion occurred despite the sharp rise in oil prices. I discuss the role of easy money in stimulating mortgage borrowing which generated negative savings in 2005. Looking ahead, I comment on the risk to inflation implied by the rising unit labor costs over the past four years. Chapter six deals with the international position of the United States. It provides a useful analysis of capital flows to the United States and the reasons why other countries have current account surpluses. It does not deal with the role of the dollar or the nature of the adjustment that might occur to reduce the US current account deficit. I present some comments on those issues. Economics
This study examines the reasons for changes in the real exchange rate between the dollar and the German mark from the beginning of the floating rate regime in 1973 through 1984. The econometric analysis focuses on the effects of anticipated structural budget deficits and monetary policy in the United States and Germany and the changes in U.S. profitability induced by changes in tax rules. The possible impact of a number of other variables is also examined. The evidence indicates that the rise in the expected future deficits in the budget of the U.S. government has had a powerful effect on the exchangerate between the dollar and the German mark. Each one percentage point increase in the ratio of future budget deficits to GNP increased the exchange rate by about 30 percentage points. Changes in the growth of the money supply also affect the exchange rate. Changes in the tax rules and in the inflation-tax interaction that altered the corporate demand for funds did not have any discernible effect on the exchange rate. A separate analysis confirms that there is an equilibrium structural relation between the dollar-DM rates in the United States and Germany. An increase of one percentage point in the real interestrate differential has been associated with a rise in the DM-dollar ratio of about five percent.
This paper studies exchange rate behavior in models with moving long-run equilibria incorporating alternative price-adjustment mechanisms.The paper demonstrates that price-adjustment rules proposed by Mussa andby Barro and Grossman yield models that are empirically indistinguishable from each other. For speeds of goods-market adjustment that are "too fast," the Barro-Grossman rule appears to induce instability; but we argue that when the ruleis interpreted properly, models incorporating it are dynamically stable regardless of the speed at which disequilibriumis eliminated. The Barro-Grossman pricing scheme is shown to be a natural generalization, to a setting of moving long-run equilibria, of less versatile schemes proposed in earlier literature on exchange rate dynamics.
This paper develops a framework of approximate account idntities that is used to discuss the limitations of existing empirical models of exchange rate determination. The poor explanatory power of the empirical models of the Seventies has now been well documented by Meese Rogoff and Backus. in this paper the limitations are first addressed by using the account framework to demonastrate that some commonly-adopted behavioral assumptions cannot jointly explain a major portion of exchange rate movements. The middle sections of the paper address some issues in modeling how "news" leads to revisions in the expectational terms that enter the exchange-rate accounting framework. The final section illustrate the issues by drawing inferences and conjectures about the types of news that contributed to the major swings in mark/dollar exchange rates (spot and forward) during 1980-81. The paper stops short of using the account framework as a building block for conducting regression tests of specific behavioral asumptions about the expectational terms.
This paper uses a novel test to see whether the Meese (1985) and Woo (1985) models are consistent with the variability of the deutschemark-dollar exchange rate 1974–84. The answer, perhaps surprisingly, is yes. Both models, however, explain the month-to-month variability as resulting in a critical way from unobservable shocks to money demand and purchasing power parity. It would therefore be of interest in future work to model one or both of these shocks as explicit functions of economic variables.
This paper explores a new direction for empirical models of exchange rate determination. The motivation arises from two well documented facts, the failure of log-linear empirical exchange rate models of the 1970's and the variability of risk premiums in the forward market. Rational maximizing models of economic behavior imply that changes in the conditional variances of exogenous processes, such as future monetary policies, future government spending, and future rates of income growth, can have a significant effect on risk premiums in the foreign exchange market and can induce conditional volatility of spot exchange rates. I examine theoretically how changes in these exogenous conditional variances affect the level of the current exchange rate, and I attempt to quantify the extent that this channel explains exchange rate volatility using autoregressive conditional heteroscedastic models.Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
This paper describes a simple method of calculating a heteroskedasticity and autocorrelation consistent covariance matrix that is positive semi-definite by construction. It also establishes consistency of the estimated covariance matrix under fairly general conditions.
The relationship between cointegration and error correction models, first suggested by Granger, is here extended and used to develop estimation procedures, tests, and empirical examples. A vector of time series is said to be cointegrated with cointegrating vector a if each element is stationary only after differencing while linear combinations a8xt are themselves stationary. A representation theorem connects the moving average , autoregressive, and error correction representations for cointegrated systems. A simple but asymptotically efficient two-step estimator is proposed and applied. Tests for cointegration are suggested and examined by Monte Carlo simulation. A series of examples are presented. Copyright 1987 by The Econometric Society.
This paper describes a method for estimating and testing nonlinear rational expectations models directly from stochastic Euler equations. The estimation procedure makes sample counterparts to the population orthogonality conditions implied by the economic model close to zero. An attractive feature of this method is that the parameters of the dynamic objective functions of economic agents can be estimated without explicitly solving for the stochastic equilibrium.
This paper studies estimators that make sample analogues of population orthogonality conditions close to zero. Strong consistency and asymptotic normality of such estimators is established under the assumption that the observable variables are stationary and ergodic. Since many linear and nonlinear econometric estimators reside within the class of estimators studied in this paper, a convenient summary of the large sample properties of these estimators, including some whose large sample properties have not heretofore been discussed, is provided.
In this paper, we investigate the link between the real foreign exchange value of the dollar and real interest rates since 1979. We argue that it is important to consider the possibility that real exchange rate movements reflect movements of the long-run equilibrium exchange rate as well as real interest differentials. We use a state-space approach to estimate the importance of shifts in the long-run equilibrium exchange rate, the persistence of the ex ante short-term real interest differential, and the effect of this differential on the exchange rate. Using U.S., Canadian, British, German and Japanese data from October 1979 to March 1986, we find that movements in the dollar real exchange rate have been dominated by unanticipated shifts in the expected long-run real exchange rate. Ex ante real interest differentials have not been persistent or variable enough to account for a major part of exchange rate variation. We use Mussa's (1984) rational expectations model of the real exchange rate and the current account to interpret our results. Economics
The present paper is intended to accomplish two tasks. First, models predicting overshooting and magnification, respectively, will be checked for their consistency with two key empirical regularities: A. The observed pattern of price level vs. exchange-rate volatility. B. The observed pattern of spot exchange-rate vs. forward exchange-rate volatility. Second, a widely neglected reason for exchange-rate volatility, activist monetary policy, will be studied.
Recent development cooperation with Guinea-Bissau, focusing on good governance, statebuilding and conflict prevention, did not contribute to democratization nor to the stabilization of volatile political, military and economic structures. The portrayal of Guinea- Bissau as a failed “narco-state”, as well as Western aid meant to stabilize this state, are both based on dubious concepts. Certainly, the impact of drug trafficking could endanger democratization and state-building if continued unchecked. However, the most pressing need is not state-building facilitated by external aid that is poorly rooted in the social and political fabric of the country. Rather, it is grassroots nation-building that is a pre-condition for the creation of viable state institutions.
This paper provides general conditions which ensure consistency and asymptotic normality for the nonlinear least squares estimator. These conditions apply to time-series, cross-section, panel, or experimental data for single equations as well as systems of equations. The regression errors may be serially correlated and/or heteroscedastic. For an important special case, we propose a new covariance matrix estimator which is consistent regardless of the presence of heteroscedasticity or serial correlation of unknown form. We also give some new tests for model misspecification, based on the information matrix testing principle.
The equilibrium growth model is modified and used to explain the cyclical variances of a set of economic time series, the covariances between real output and the other series, and the autocovariance of output. The model is fitted to quarterly data for the post-war U.S. economy. Crucial features of the model are the assumption that more than one time period is required for the construction of new productive capital, and the non-time-separable utility function that admits greater intertemporal substitution of leisure. The fit is surprisingly good in light of the model's simplicity and the small number of free parameters.
This paper investigates the distribution of the least squares estimator of the coefficient α in the model @c"t = @a@c"t -"1 + @?"t where the @?"t where the @?"t are independently distributed N (O, @s^2). The exact finite sample and limiting distributions are calculated when α ≥ 1 and finite sample distributions when α
Analysts of regional growth differences in the US tend to assume full spatial equilibrium (Glaeser et al, 1995). Flows of people thus indicate changes in the distribution of spatial welfare more effectively than differences in incomes. Research in Europe, however, shows that people tend to be immobile. Even mobility within countries is restricted compared to the US but national boundaries offer particular barriers to spatial adjustment. Thus it is less reasonable to assume full spatial equilibrium in a European context and differences in per capita incomes may persist and signal real spatial welfare differences. Furthermore, it implies that the drivers of what population movement there is, may differ from the drivers of spatial differences in productivity or output growth. This paper analyses the drivers of differential urban growth in the EU both in terms of population and output growth. The results show significant differences in the drivers as well as common ones. They also reveal the extent to which national borders still impede spatial adjustment in Europe. This has important implications for policy and may apply more generally to countries – for example China - less homogeneous than the USA.
In this paper various methods for the estimation of simultaneous equation models with lagged endogenous variables and lirst order serially correlated errors are discussed. The methods differ in the number of instrumental variables used. The asymptotic and small sample properties of the various methods are compared, and the variables which must be included as instruments to insure consistent estimates are derived. A suggestion on how to estimate the approximate covariance matrix of the estimators is made. 1. INTRODUCTION RECENTLY SARGAN (8) has proposed various maximum likelihood estimators for the estimation of simultaneous equation models with serially correlated errors, and Amemiya (l) has considered the two stage least squares analogue to one of Sargan's estimators and has proposed a modified version of this analogue. Because of the large number of instrumental variables which it uses, Sargan's method (or the two stage least squares analogue) is likely to be of limited practical use, and this paper discusses which of Sargan's instrumental variables should be retained in order to insure consistent estimates. One method is proposed that is asymptotic- ally equivalent to Sargan's method, but which uses fewer instrumental variables and may have less small sample bias. Further suggestions are made for substantially decreasing the number of instrumental variables with perhaps small loss of asymptotic efficiency. Amemiya's method is then briefly discussed and compared with the methods proposed in this paper. The paper concludes with a discussion of the asymptotic covariance matrices of the estimators.
This study examines the out-of-sample forecasting performance of models of exchange rate determination without imposing the restriction that coefficients are fixed over time. Both fixed and variable coefficient versions of conventional structural models are considered, with and without a lagged dependent variable. While our results on fixed coefficient models support most of the Meese and Rogoff conclusions, we find that when coefficients are allowed to change, an important subset of conventional models of the dollar-pound, the dollar-deutsche mark, and the dollar-yen exchange rates can outperform forecasts of a random walk model. The structural models considered are the flexible-price (Frenkel-Bilson) and sticky-price (Dornbusch-Frankel) monetary models, and a sticky-price model which includes the current account (Hooper-Morton).
This paper develops a model of exchange rate determination that extends the Dornbusch-Frankel model to allow for large and sustained changes in real exchange rates. Real exchange rate changes are related to movements in the current account, both through changes in expectations about the long-run equilibrium real exchange rate and through changes in the risk premium. The model is estimated empirically for the dollar's weighted average exchange rate over the flexible rate period of the 1970s. The results indicate that innovations to the current account have been a significant determinant of the exchange rate, predominantly through changes in expectations.
Real Determinants of Real Exchange Rates Unpublished manuscript, Uni-versity of Chicago
- Robert J Barro
Robert J. Barro. " Real Determinants of Real Exchange Rates. " Unpublished manuscript, Uni-versity of Chicago, 1983.
Risk, Uncertainty and Exchange Rates Unpublished manuscript
- Robert J Hodrick
Robert J. Hodrick. " Risk, Uncertainty and Exchange Rates. " Unpublished manuscript, North-western University, 1987.
- Hodrick