Forecasting and combining competing models of exchange rate determination

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 te...

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Bibliographic Details
Published in:Applied economics 2010-11, Vol.42 (27), p.3455-3480
Main Authors: Altavilla, Carlo, De Grauwe, Paul
Format: Article
Language:English
Subjects:
Comparative analysis
Economic forecasting
Economic models
Equilibrium
Exchange rate determination
Forecasting techniques
Forecasts
Foreign exchange rates
Linear models
Modelling
Non-linear models
Studies
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Summary: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.
ISSN:0003-6846
1466-4283
DOI:10.1080/00036840802112505