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Can Economists Forecast Exchange Rates? The Debate R e‐Visited: The Case of the USD / GBP Market
Author(s) -
Goss Barry A.,
Avsar S. Gulay
Publication year - 2016
Publication title -
australian economic papers
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.351
H-Index - 15
eISSN - 1467-8454
pISSN - 0004-900X
DOI - 10.1111/1467-8454.12057
Subject(s) - rational expectations , economics , exchange rate , order (exchange) , econometrics , simultaneity , forward rate , pessimism , speculation , sample (material) , financial economics , foreign exchange market , random walk , monetary economics , macroeconomics , interest rate , statistics , finance , mathematics , philosophy , chemistry , physics , classical mechanics , epistemology , chromatography
In the debate on forecasting exchange rates, critics claimed that traditional macroeconomic models could not outperform a random walk in post‐sample forecasts. Perceived deficiencies include inadequate allowance for simultaneity, and expectations hypotheses inconsistent with the structure of models employed. This paper re‐visits the debate, first to address critics' major concerns, and second because in the view of the present authors, the debate closed on an unduly pessimistic note. This paper develops a simultaneous, rational expectations model of the USD / GBP market, with functional relationships for hedgers, speculators and a spot rate equation. The model is estimated with data contemporaneous to the debate, including a period during which the US C ommodity F utures T rading C ommission did not collect data on traders' open positions. Using the results of post‐debate research on tests for stationarity with missing observations, the model, using only public information, outperforms a random walk in post‐sample forecasts of the spot rate. Recent microstructure models of the exchange rate based on order flow have re‐kindled the forecasting debate. The model developed here, however, is differentiated from these microstructure models, first because order flow utilises both public and private information, and second because the microstructure models do not directly address critics' concerns.