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Journal of Economic Literature: Vol. 51 No. 4 (December 2013)

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Exchange Rate Predictability

Article Citation

Rossi, Barbara. 2013. "Exchange Rate Predictability." Journal of Economic Literature, 51(4): 1063-1119.

DOI: 10.1257/jel.51.4.1063

Abstract

The main goal of this article is to provide an answer to the question: does anything forecast exchange rates, and if so, which variables? It is well known that exchange rate fluctuations are very difficult to predict using economic models, and that a random walk forecasts exchange rates better than any economic model (the Meese and Rogoff puzzle). However, the recent literature has identified a series of fundamentals/ methodologies that claim to have resolved the puzzle. This article provides a critical review of the recent literature on exchange rate forecasting and illustrates the new methodologies and fundamentals that have been recently proposed in an up-to-date, thorough empirical analysis. Overall, our analysis of the literature and the data suggests that the answer to the question: "Are exchange rates predictable?" is, "It depends"—on the choice of predictor, forecast horizon, sample period, model, and forecast evaluation method. Predictability is most apparent when one or more of the following hold: the predictors are Taylor rule or net foreign assets, the model is linear, and a small number of parameters are estimated. The toughest benchmark is the random walk without drift.

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Authors

Rossi, Barbara (ICREA, U Pompeu Fabra and Barcelona GSE)

JEL Classifications

C53: Forecasting Models; Simulation Methods
F31: Foreign Exchange
F37: International Finance Forecasting and Simulation: Models and Applications
E43: Interest Rates: Determination, Term Structure, and Effects
E52: Monetary Policy


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