Exchange Rate Predictability in a Changing World

Byrne, Joseph P and Korobilis, Dimitris and Ribeiro, Pinho J (2014): Exchange Rate Predictability in a Changing World.

Abstract

An expanding literature articulates the view that Taylor rules are helpful in predicting exchange rates. In a changing world however, Taylor rule parameters may be subject to structural instabilities, for example during the Global Financial Crisis. This paper forecasts exchange rates using such Taylor rules with Time Varying Parameters (TVP) estimated by Bayesian methods. In core out-of-sample results, we improve upon a random walk benchmark for at least half, and for as many as eight out of ten, of the currencies considered. This contrasts with a constant parameter Taylor rule model that yields a more limited improvement upon the benchmark. In further results, Purchasing Power Parity and Uncovered Interest Rate Parity TVP models beat a random walk benchmark, implying our methods have some generality in exchange rate prediction.

• Item Type: MPRA Paper
• Language: English
• Keywords: Exchange Rate Forecasting; Taylor Rules; Time-Varying Parameters; Bayesian Methods.
• Subjects: C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C53 - Forecasting and Prediction Methods ; Simulation Methods; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; F - International Economics > F3 - International Finance > F31 - Foreign Exchange; F - International Economics > F3 - International Finance > F37 - International Finance Forecasting and Simulation: Models and Applications; G - Financial Economics > G1 - General Financial Markets > G17 - Financial Forecasting and Simulation

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