Medium-Term Exchange Rate Forecasting : What Can We Expect?

Author/Editor:

Guy M Meredith

Publication Date:

January 1, 2003

Electronic Access:

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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

The medium-term predictability of exchange rate movements is examined using three models of fundamentals: purchasing power parity, the monetary model, and uncovered interest parity. While the first two approaches yield favorable in-sample results, these largely reflect finite-sample estimation biases. Adjusting for these biases, there is little evidence of predictability, consistent with the lack of systematic improvement in out-of-sample forecasting performance relative to a random walk. Uncovered interest parity fares better at long horizons, but reflects information already embodied in market prices; in this sense, it may not be useful as an indicator of exchange rate misalignment. While more elaborate models of fundamentals might have better medium-term forecasting properties, careful attention must be paid to finite-sample biases in assessing predictability.

Series:

Working Paper No. 03/21

Subject:

English

Publication Date:

January 1, 2003

ISBN/ISSN:

9781451843934/1018-5941

Stock No:

WPIEA0212003

Format:

Paper

Pages:

31

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