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37
Exchange Rate Models Are Not as Bad as You Think
 NBER MACROECONOMICS ANNUAL
, 2007
"... Standard models of exchange rates, based on macroeconomic variables such as prices, interest rates, output, etc., are thought by many researchers to have failed empirically. We present evidence to the contrary. First, we emphasize the point that “beating a random walk” in forecasting is too strong a ..."
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Cited by 52 (4 self)
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Standard models of exchange rates, based on macroeconomic variables such as prices, interest rates, output, etc., are thought by many researchers to have failed empirically. We present evidence to the contrary. First, we emphasize the point that “beating a random walk” in forecasting is too strong a criterion for accepting an exchange rate model. Typically models should have low forecasting power of this type. We then propose a number of alternative ways to evaluate models. We examine insample fit, but emphasize the importance of the monetary policy rule, and its effects on expectations, in determining exchange rates. Next we present evidence that exchange rates incorporate news about future macroeconomic fundamentals, as the models imply. We demonstrate that the models might well be able to account for observed exchangerate volatility. We discuss studies that examine the response of exchange rates to announcements of economic data. Then we present estimates of exchangerate models in which expected present values of fundamentals are calculated from survey forecasts. Finally, we show that outofsample forecasting power of models can be increased by focusing on panel estimation and longhorizon forecasts.
Frontiers of realtime data analysis
 Journal of Economic Literature
, 2011
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Changing monetary policy rules, learning, and real exchange rate dynamics
 Journal of Money, Credit and Banking
, 2009
"... When the exchange rate is priced by uncovered interest parity and central banks set nominal interest rates according to a reaction function such as the Taylor rule, the real exchange rate will be determined by expected inflation differentials and output gap or unemployment gap differentials. In this ..."
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Cited by 29 (2 self)
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When the exchange rate is priced by uncovered interest parity and central banks set nominal interest rates according to a reaction function such as the Taylor rule, the real exchange rate will be determined by expected inflation differentials and output gap or unemployment gap differentials. In this paper I examine the implications of these Taylorrule fundamentals for real exchange rate determination in an environment in which market participants are ignorant of the numerical values of the model’s coefficients but use leastsquares learning rules to acquire that information. I report evidence that this simple learning environment provides a plausible framework for understanding real deutschemark—dollar exchange rate from 1973 to 2005. The leastsquares learning path for the real exchange rate is able to capture six major swings observed in the data. An earlier version of this paper was presented at Mussafest, a conference in honor of Michael Mussa’s 60th
CONVENTIONAL AND UNCONVENTIONAL APPROACHES TO EXCHANGE RATE MODELLING AND ASSESSMENT
, 2008
"... We examine the relative predictive power of the sticky price monetary model, uncovered interest parity, and a transformation of net exports and net foreign assets. In addition to bringing Gourinchas and Rey’s new approach and more recent data to bear, we implement the Clark–West procedure for testin ..."
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Cited by 24 (7 self)
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We examine the relative predictive power of the sticky price monetary model, uncovered interest parity, and a transformation of net exports and net foreign assets. In addition to bringing Gourinchas and Rey’s new approach and more recent data to bear, we implement the Clark–West procedure for testing the significance of outofsample forecasts. The interest rate parity relation holds better at long horizons and the net exports variable does well in predicting exchange rates at short horizons in sample. In outofsample forecasts, we find evidence that our proxy for Gourinchas and Rey’s measure of external imbalances outperforms a random walk at short horizons as do some of the other models, although no single model uniformly beats the random walk forecast.
Taylor rules with realtime data: A tale of two countries and one exchange rate
 Journal of Monetary Economics
, 2008
"... Using realtime data that reflects information available to monetary authorities at the time they are formulating policy, we find that estimated Taylor rules based on revised and realtime data differ more for Germany than for the U.S., Taylor rules using realtime data suggest differences between U ..."
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Cited by 20 (4 self)
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Using realtime data that reflects information available to monetary authorities at the time they are formulating policy, we find that estimated Taylor rules based on revised and realtime data differ more for Germany than for the U.S., Taylor rules using realtime data suggest differences between U.S. and German monetary policies, and Taylor rules for the U.S. using inflation forecasts are nearly identical to those using lagged inflation rates. Evidence of outofsample predictability for the dollar/mark nominal exchange rate with forecasts based on Taylor rule fundamentals is only found with realtime data and does not increase if inflation forecasts are used. JEL classification: C2, E5, F3
Yield Curve Predictors of Foreign Exchange Returns ∗
, 2010
"... uncovered interest rate parity We thank Rudy LooKung for some research assistance work. We especially thank Bob Hodrick ..."
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Cited by 18 (0 self)
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uncovered interest rate parity We thank Rudy LooKung for some research assistance work. We especially thank Bob Hodrick
The Taylor rule and forecast intervals for exchange rates,
 Journal of Money, Credit and Banking,
, 2012
"... In this paper, we examine the MeeseRogoff puzzle from a different perspective: outofsample interval forecasting. While most studies in the literature focus on point forecasts, we apply semiparametric interval forecasting to a group of exchange rate models. Forecast intervals for 10 OECD exchange ..."
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Cited by 9 (0 self)
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In this paper, we examine the MeeseRogoff puzzle from a different perspective: outofsample interval forecasting. While most studies in the literature focus on point forecasts, we apply semiparametric interval forecasting to a group of exchange rate models. Forecast intervals for 10 OECD exchange rates are generated and the performance of the empirical exchange rate models are compared with the random walk. Our contribution is twofold. First, we find that in general, exchange rate models generate tighter forecast intervals than the random walk, given that their intervals cover outofsample exchange rate realizations equally well. Our results suggest a connection between exchange rates and economic fundamentals: economic variables contain information useful in forecasting distributions of exchange rates. We also find that the benchmark Taylor rule model performs better than the monetary, PPP and forward premium models, and its advantages are more pronounced at longer horizons. Second, the bootstrap inference framework proposed in this paper for forecast interval evaluation can be applied in a broader context, such as inflation forecasting. JEL codes: C14, C53, F31 Keywords: MeeseRogoff puzzle, exchange rate forecast, interval forecasting, Taylor rule model. IN A SEMINAL PAPER, We are grateful to Editor Ken West and two anonymous referees for valuable comments and suggestions that greatly improved the paper. We also thank
Taylor Rules and the Euro
 Journal of Money, Credit and Banking
, 2011
"... This paper uses realtime data to show that inflation and either the output gap or unemployment, the variables which normally enter central banks ’ Taylor rules for interestratesetting, can provide evidence of outofsample predictability and forecasting ability for the United States Dollar/Euro e ..."
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Cited by 5 (1 self)
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This paper uses realtime data to show that inflation and either the output gap or unemployment, the variables which normally enter central banks ’ Taylor rules for interestratesetting, can provide evidence of outofsample predictability and forecasting ability for the United States Dollar/Euro exchange rate from the inception of the Euro in 1999 to the end of 2007. We also present less formal evidence that, with realtime data, the Taylor rule provides a better description of ECB than of Fed policy during this period. The strongest evidence is found for specifications that neither incorporate interest rate smoothing nor include the real exchange rate in the forecasting regression, and the results are robust to whether or not the coefficients on inflation and the real economic activity measure are constrained to be the same for the U.S. and the Euro Area. The evidence is stronger with inflation forecasts than with inflation rates and with realtime data than with revised data. Bad news about inflation and good news about real economic activity both lead to outofsample predictability and forecasting ability through forecasted exchange rate appreciation.
Econometric analysis of Present Value Models when the Discount Factor is Near One,” mimeo
, 2008
"... This paper develops asymptotic econometric theory to help understand data generated by a present value model with a discount factor near one. A leading application is to exchange rate models. A key assumption of the asymptotic theory is that the discount factor approaches 1 as the sample size grows. ..."
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Cited by 4 (0 self)
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This paper develops asymptotic econometric theory to help understand data generated by a present value model with a discount factor near one. A leading application is to exchange rate models. A key assumption of the asymptotic theory is that the discount factor approaches 1 as the sample size grows. The finite sample approximation implied by the asymptotic theory rationalizes near random walk behavior in asset prices as well as certain aspects of regressions relating spot and forward exchange rates.