Medium-Term Exchange Rate Forecasting: What Can We Expect?

January 1, 2003

Preview Citation

Format: Chicago

Guy M Meredith. Medium-Term Exchange Rate Forecasting: What Can We Expect?, (USA: International Monetary Fund, 2003) accessed November 21, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

The medium-term predictability of exchange rate movements is examined using three models of fundamentals: purchasing power parity, the monetary model, and uncovered interest parity. While the first two approaches yield favorable in-sample results, these largely reflect finite-sample estimation biases. Adjusting for these biases, there is little evidence of predictability, consistent with the lack of systematic improvement in out-of-sample forecasting performance relative to a random walk. Uncovered interest parity fares better at long horizons, but reflects information already embodied in market prices; in this sense, it may not be useful as an indicator of exchange rate misalignment. While more elaborate models of fundamentals might have better medium-term forecasting properties, careful attention must be paid to finite-sample biases in assessing predictability.

Subject: Exchange rate adjustments, Exchange rates, Financial services, Foreign exchange, Interest rate parity, Purchasing power parity, Real effective exchange rates

Keywords: Adjustment parameter, Exchange rate, Exchange rate adjustments, Exchange rate movement, Exchange rates, Forecasting, Forward rate, Interest rate parity, Mean reversion, Mean-reversion regression, Null hypothesis, Purchasing power parity, Random walk, Real effective exchange rates, Sample estimation result, Sample period, WP

Publication Details

Pages:

31
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2003/021
Stock No:

WPIEA0212003
ISBN:

9781451843934
ISSN:

1018-5941

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