Long-Horizon Exchange Rate Predictability?

Abstract

Several authors have recently investigated the predictability of exchange rates by fitting a sequence of long-horizon error-correction equations. We show by means of a simulation study that, in small to medium samples, inference from this regression procedure depends on the null hypothesis that is used to generate empirical critical values. The standard assumption of a stationary error-correction term between exchange rates and fundamentals biases the results in favor of predictive power. Our results show that evidence of long-horizon predictability weakens when using empirical critical values generated under the more stringent null of no cointegration. Likewise, results are weakened using critical values generated under the null that exchange rates and fundamentals are generated by an unrestricted VAR with no integration restrictions. © 2000 by the President and Fellows of Harvard College and the Massachusetts Institute of Technology

The Predictive Information Content of External Imbalances for Exchange Rate Returns: How Much Is It Worth?

“…Economic fundamentals can generally explain at most a small part of nominal exchange rate changes (Meese and Rogo¤, 1983;Mark, 1995;Kilian, 1999;Berkowitz and Giorgianni, 2001;Engel, Mark and West, 2008). There are a number of explanations for this apparent "disconnect"puzzle.…”

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“…(3) and (4). Their …nding has been con…rmed by Chinn and Meese (1995) The robustness of Mark's (1995) …ndings has, however, been questioned by Berkowitz and Giorgianni (2001), Kilian (1999), , Faust et al (2003) and Rossi (2005a).…”

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“…Mark and Sul, [2001] study the long-run relationship between nominal exchange rates and monetary fundamentals for a panel of 19 countries and find that exchange rates are cointegrated with long-run determinants predicted by economic theory and that panel based forecasts have a significant forecasting power. However, others remain still sceptical and begin to criticise Mark, [1995] methodology and the resultant conclusions (see Kilian, [1999], Berkowitz and Giorgianni, [2001], Faust et al, [2003] and Neely and Sarno, [2002]). …”