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On Cointegration and Exchange Rate Dynamics
Author(s) -
DIEBOLD FRANCIS X.,
GARDEAZABAL JAVIER,
YILMAZ KAMIL
Publication year - 1994
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.1994.tb05160.x
Subject(s) - cointegration , econometrics , economics , us dollar , martingale (probability theory) , exchange rate , mathematics , statistics , monetary economics
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.