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The importance of interest rates for forecasting the exchange rate
Author(s) -
Bjørnland Hilde C.,
Hungnes Håvard
Publication year - 2006
Publication title -
journal of forecasting
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.543
H-Index - 59
eISSN - 1099-131X
pISSN - 0277-6693
DOI - 10.1002/for.983
Subject(s) - purchasing power parity , exchange rate , random walk , econometrics , interest rate , representation (politics) , interest rate parity , sample (material) , economics , computer science , statistics , mathematics , macroeconomics , chemistry , chromatography , politics , political science , law
This study compares the forecasting performance of a structural exchange rate model that combines the purchasing power parity condition with the interest rate differential in the long run, with some alternative exchange rate models. The analysis is applied to the Norwegian exchange rate. The long‐run equilibrium relationship is embedded in a parsimonious representation for the exchange rate. The structural exchange rate representation is stable over the sample and outperforms a random walk in an out‐of‐sample forecasting exercise at one to four horizons. Ignoring the interest rate differential in the long run, however, the structural model no longer outperforms a random walk. Copyright © 2006 John Wiley _ Sons, Ltd.