On Cointegration and Exchange Rate Dynamics

Baillie and Bollerslev (1989) have recently argued that nominal dollar spot exchange rates are cointegrated. Here we examine an immediate implication of their finding, namely, that cointegration implies an error-correction representation yielding forecasts superior to those from a martingale benchma...

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Bibliographic Details
Published in:The Journal of finance (New York) 1994-06, Vol.49 (2), p.727-735
Main Authors: DIEBOLD, FRANCIS X., GARDEAZABAL, JAVIER, YILMAZ, KAMIL
Format: Article
Language:English
Subjects:
Analytical forecasting
Economic models
Exchange rates
Forecasting models
Foreign exchange rates
Liras
Martingales
Matrices
Null hypothesis
Regression analysis
Shorter Papers
Studies
Vector autoregression
White noise
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Summary:Baillie and Bollerslev (1989) have recently argued that nominal dollar spot exchange rates are cointegrated. Here we examine an immediate implication of their finding, namely, that cointegration implies an error-correction representation yielding forecasts superior to those from a martingale benchmark, in light of a large earlier literature highlighting the predictive superiority of the martingale. In an out-of-sample forecasting exercise, we find the martingale model to be superior. We then perform a battery of improved cointegration tests and find that the evidence for cointegration is much less strong than previously thought, a result consistent with the outcome of the forecasting exercise.
ISSN:0022-1082
1540-6261
DOI:10.1111/j.1540-6261.1994.tb05160.x