Can Panel Data Really Improve the Predictability of the Monetary Exchange Rate Model?

Westerlund, Joakim and Basher, Syed A. (2006): Can Panel Data Really Improve the Predictability of the Monetary Exchange Rate Model?

Abstract

A common explanation for the inability of the monetary model to beat the random walk in forecasting future exchange rates is that conventional time series tests may have low power, and that panel data should generate more powerful tests. This paper provides an extensive evaluation of this power argument to the use of panel data in the forecasting context. In particular, by using simulations it is shown that although pooling of the individual prediction tests can lead to substantial power gains, pooling only the parameters of the forecasting equation, as has been suggested in the previous literature, does not seem to generate more powerful tests. The simulation results are illustrated through an empirical application.

• Item Type: MPRA Paper
• Institution: York University
• Language: English
• Keywords: Monetary Exchange Rate Model; Forecasting; Panel Data; Pooling; Bootstrap
• Subjects: F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F47 - Forecasting and Simulation: Models and Applications; F - International Economics > F3 - International Finance > F31 - Foreign Exchange; C - Mathematical and Quantitative Methods > C3 - Multiple or Simultaneous Equation Models ; Multiple Variables > C32 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes ; State Space Models; C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods and Methodology: General > C15 - Statistical Simulation Methods: General; C - Mathematical and Quantitative Methods > C3 - Multiple or Simultaneous Equation Models ; Multiple Variables > C33 - Panel Data Models ; Spatio-temporal Models

References

Banerjee, A., Marcellino, M., and Osbat, C. (2004). Some cautions on the use of panel methods for integrated series of macroeconomic data. Econometric Journal 7, 322-340.

Banerjee, A., Marcellino, M., and Osbat, C. (2005). Testing for PPP: Should we use panel methods? Empirical Economics 30, 77-91.

Berben, R.-P., and van Dijk, D. J. C. (1998). Does the absence of cointegration explain the typical findings in long horizon regressions? Econometric Institute Report 145, Erasmus University Rotterdam, Econometric Institute.

Berkowitz, J., and Giorgianni, L. (2001). Long-horizon exchange rate predictability? Review of Economics and Statistics 83, 81-91.

Diebold, F. X., and Mariano, R. S. (1995). Comparing predictive accuracy. Journal of Business and Economic Statistics 13, 253-63.

Engel, C. (2000). Long-run PPP may not hold after all. Journal of International Economics 51, 243-73.

Gengenbach, C., Palm, F. C., and Urbain, J-P. (2006). Panel cointegration testing in the presence of common factors. Oxford Bulletin of Economics and Statistics 68, 683-719.

Groen, J. J. J. (1999). Long-horizon predictability of exchange rates: Is it for real? Empirical Economics 24, 451-69.

Groen, J. J. J. (2000). The monetary exchange rate model as a long-run phenomenon. Journal of International Economics 52, 299-319.

Kilian, L. (1999). Exchange rates and monetary fundamentals: What do we learn from long-horizon regressions? Journal of Applied Econometrics 14, 491-510.

Mark, N. C. (1995). Exchange rates and fundamentals: Evidence on longhorizon predictability. American Economic Review 85, 201-18.

Mark, N. C., and Sul, D. (2001). Nominal exchange rates and monetary fundamentals: Evidence from a small post-Bretton Woods panel. Journal of International Economics 53, 29-52.

Meese, R. A., and Rogoff, K. (1983). Empirical exchange rate models of the seventies: Do they fit out of sample? Journal of International Economics 14, 3-24.

Papell, D. H. and Theodoridis, H. (2001). The choice of numeraire currency in panel tests of purchasing power parity. Journal of Money, Credit and Banking 33, 790-803.

Rapach, D. E., and Wohar, M. E. (2002). Testing the monetary model of exchange rate determination: New evidence from a century of data. Journal of International Economics 58, 359-385.

Rapach, D. E., and Wohar, M. E. (2004). Testing the monetary model of exchange rate determination: A closer look at panels. Journal of International Money and Finance 23, 867-895.

Taylor, M. P., and Sarno, L. (1998). The behavior of real exchange rates during the post-Bretton Woods period. Journal of International Economics 46, 281-312.