Forecasting and combining competing models of exchange rate determination

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Abstract:

This article investigates the out-of-sample forecast performance of a set of competing models of exchange rate determination. We compare standard linear models with models that characterize the relationship between exchange rate and the underlying fundamentals by nonlinear dynamics. Linear models tend to outperform at short forecast horizons especially when deviations from long-term equilibrium are small. In contrast, nonlinear models with more elaborate mean-reverting components dominate at longer horizons especially when deviations from long-term equilibrium are large. The results also suggest that combining different forecasting procedures generally produces more accurate forecasts than can be attained from a single model.

Document Type: Research Article

DOI: http://dx.doi.org/10.1080/00036840802112505

Affiliations: 1: Department of Economic Studies, University of Naples 'Parthenope', Naples, Italy 2: Department of Economics, Catholic University of Leuven, Leuven, Belgium

Publication date: November 1, 2010

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