Michał Rubaszek
- 26 September 2022
- WORKING PAPER SERIES - No. 2731Details
- Abstract
- We build currency portfolios based on the paradigm that exchange rates slowly converge to their equilibrium to highlight three results. First, this property can be exploited to build profitable portfolios. Second, the slow pace of convergence at short-horizons is consistent with the evidence of profitable carry trade strategies, i.e. the common practice of borrowing in low-yield currencies and investing in high-yield currencies. Third, the predictive power of equilibrium exchange rates may boost the performance of carry trade strategies.
- JEL Code
- F31 : International Economics→International Finance→Foreign Exchange
G12 : Financial Economics→General Financial Markets→Asset Pricing, Trading Volume, Bond Interest Rates
G15 : Financial Economics→General Financial Markets→International Financial Markets
- 11 November 2021
- ECONOMIC BULLETIN - ARTICLEEconomic Bulletin Issue 7, 2021Details
- Abstract
- This article reviews three popular equilibrium exchange rate models, the purchasing power parity (PPP), behavioural equilibrium exchange rate (BEER) and macroeconomic balance (MB) models. The aim is to address two questions: whether such models help in forecasting real and nominal exchange rates and which macroeconomic fundamentals contain such predictive power. The evidence suggests that real exchange rates adjust over time to their estimated real exchange rate equilibria only in the cases of the PPP and BEER models. Exploring this empirical regularity, it is possible to draw three important lessons. The first is that such equilibrium adjustment helps to forecast real exchange rates. The second lesson is that this real equilibrium adjustment process helps in forecasting nominal exchange rates, as most of the adjustment toward equilibrium is achieved by currency movements and not by relative price changes. The third is that most of the forecasting power comes from the exploitation of the mean-reverting properties of real exchange rates rather than an understanding of the relationship between exchange rates and economic fundamentals.
- JEL Code
- C33 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Panel Data Models, Spatio-temporal Models
F31 : International Economics→International Finance→Foreign Exchange
F37 : International Economics→International Finance→International Finance Forecasting and Simulation: Models and Applications
F41 : International Economics→Macroeconomic Aspects of International Trade and Finance→Open Economy Macroeconomics
- 9 January 2020
- WORKING PAPER SERIES - No. 2358Details
- Abstract
- In this paper we evaluate the predictive power of the three most popular equilibrium exchange rate concepts: Purchasing Power Parity (PPP), Behavioral Equilibrium Exchange Rate (BEER) and the Macroeconomic Balance (MB) approach. We show that there is a clear trade-off between storytelling and forecast accuracy. The PPP model offers little economic insights, but has good predictive power. The BEER framework, which links exchange rates to fundamentals, does not deliver forecasts of better quality than PPP. The MB approach has the most appealing economic interpretation, but performs poorly in forecasting terms. Sensitivity analysis confirms that changing the composition of fundamentals in the BEER model or modifying key underlying assumptions in the MB model does not generally enhance their predictive power.
- JEL Code
- C33 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Panel Data Models, Spatio-temporal Models
F31 : International Economics→International Finance→Foreign Exchange
F37 : International Economics→International Finance→International Finance Forecasting and Simulation: Models and Applications
F41 : International Economics→Macroeconomic Aspects of International Trade and Finance→Open Economy Macroeconomics
- 22 May 2018
- WORKING PAPER SERIES - No. 2151Details
- Abstract
- This paper shows that there are two regularities in foreign exchange markets in advanced countries with flexible regimes. First, real exchange rates are mean-reverting, as implied by the Purchasing Power Parity model. Second, the adjustment takes place via nominal exchange rates. These features of the data can be exploited, even on the back of a napkin, to generate nominal exchange rate forecasts that outperform the random walk. The secret is to avoid estimating the pace of mean reversion and assume that relative prices are unchanged. Direct forecasting or panel data techniques are better than the random walk but fail to beat this simple calibrated model.
- JEL Code
- C32 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models, Diffusion Processes
F31 : International Economics→International Finance→Foreign Exchange
F37 : International Economics→International Finance→International Finance Forecasting and Simulation: Models and Applications
F41 : International Economics→Macroeconomic Aspects of International Trade and Finance→Open Economy Macroeconomics
- 13 May 2016
- WORKING PAPER SERIES - No. 1905Details
- Abstract
- We run a real exchange rate forecasting "horse race", which highlights that two principles hold. First, forecasts should not replicate the high volatility of exchange rates observed in sample. Second, models should exploit the mean reversion of the real exchange rate over long horizons. Abiding by these principles, an open-economy DSGE model performs well in real exchange rate forecasting. However, it fails to forecast nominal exchange rates better than the random walk. We find that the root cause is its inability to predict domestic and foreign inflation. This shortcoming leads us toward simpler ways to outperform the random walk.
- JEL Code
- C32 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models, Diffusion Processes
F31 : International Economics→International Finance→Foreign Exchange
F37 : International Economics→International Finance→International Finance Forecasting and Simulation: Models and Applications
- 14 August 2013
- WORKING PAPER SERIES - No. 1576Details
- Abstract
- This paper brings three new insights into the Purchasing Power Parity (PPP) debate. First, we show that a half-life PPP model is able to forecast real exchange rates (RER) better than the random walk (RW) model at both short and long-term horizons. Secondly, we find that this result holds only if the speed of adjustment to the sample mean is calibrated at reasonable values rather than estimated. Finally, we find that it is also preferable to calibrate, rather than to elicit as a prior, the parameter determining the speed of adjustment to PPP.
- JEL Code
- C32 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models, Diffusion Processes
F31 : International Economics→International Finance→Foreign Exchange
F37 : International Economics→International Finance→International Finance Forecasting and Simulation: Models and Applications
- 16 November 2012
- WORKING PAPER SERIES - No. 1492Details
- Abstract
- The paper provides a novel Bayesian methodological framework to estimate structural VAR (SVAR) models with recursive identification schemes that allows for the inclusion of over-identifying restrictions. The proposed framework enables the researcher to (i) elicit the prior on the non-zero contemporaneous relations between economic variables and to (ii) derive an analytical expression for the posterior distribution and marginal data density. We illustrate our methodological framework by estimating a backward looking New-Keynesian model taking into account prior beliefs about the contemporaneous coefficients in the Phillips curve and Taylor rule.
- JEL Code
- C11 : Mathematical and Quantitative Methods→Econometric and Statistical Methods and Methodology: General→Bayesian Analysis: General
C32 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models, Diffusion Processes
E47 : Macroeconomics and Monetary Economics→Money and Interest Rates→Forecasting and Simulation: Models and Applications
- 3 February 2012
- WORKING PAPER SERIES - No. 1420Details
- Abstract
- This paper applies a life-cycle model with individual income uncertainty to investigate the determinants of credit to households. We show that the value of household credit to GDP ratio depends on (i) the lending-deposit interest rate spread, (ii) individual income uncertainty, (iii) individual productivity persistence, and (iv) the generosity of the pension system. Subsequently, we provide empirical evidence for the predictions of the theoretical model on the basis of data for OECD and EU countries.
- JEL Code
- E21 : Macroeconomics and Monetary Economics→Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy→Consumption, Saving, Wealth
E43 : Macroeconomics and Monetary Economics→Money and Interest Rates→Interest Rates: Determination, Term Structure, and Effects
E51 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Money Supply, Credit, Money Multipliers - Network
- Macroprudential Research Network
- 25 November 2009
- WORKING PAPER SERIES - No. 1110Details
- Abstract
- Dynamic stochastic general equilibrium models have recently become standard tools for policy-oriented analyses. Nevertheless, their forecasting properties are still barely explored. We fill this gap by comparing the quality of real-time forecasts from a richly-specified DSGE model to those from the Survey of Professional Forecasters, Bayesian VARs and VARs using priors from a DSGE model. We show that the analyzed DSGE model is relatively successful in forecasting the US economy in the period of 1994-2008. Except for short-term forecasts of inflation and interest rates, it is as good as or clearly outperforms BVARs and DSGE-VARs. Compared to the SPF, the DSGE model generates better output forecasts at longer horizons, but less accurate short-term forecasts for interest rates. Conditional on experts' now casts, however, the forecasting power of the DSGE turns out to be similar or better than that of the SPF for all the variables and horizons.
- JEL Code
- C11 : Mathematical and Quantitative Methods→Econometric and Statistical Methods and Methodology: General→Bayesian Analysis: General
C32 : Mathematical and Quantitative Methods→Multiple or Simultaneous Equation Models, Multiple Variables→Time-Series Models, Dynamic Quantile Regressions, Dynamic Treatment Effect Models, Diffusion Processes
C53 : Mathematical and Quantitative Methods→Econometric Modeling→Forecasting and Prediction Methods, Simulation Methods
D58 : Microeconomics→General Equilibrium and Disequilibrium→Computable and Other Applied General Equilibrium Models
E17 : Macroeconomics and Monetary Economics→General Aggregative Models→Forecasting and Simulation: Models and Applications
- 16 May 2008
- WORKING PAPER SERIES - No. 895Details
- Abstract
- In this paper we present a novel approach to the empirical validation of the intertemporal approach to the current account. We develop a calibrated model highlighting the role of consumption smoothing and capital accumulation in the economic convergence process. After solving the model, we derive the theoretical values for the euro area countries’ current account, testing to what extent they match reality. The model explains most of the dispersion in the current account and saving ratio, though cannot equally well capture differences in the investment ratios. The conclusion that we draw is that consumption smoothing, based on expectations of economic convergence, is driving the current account of the euro area countries over medium-term horizons. Capital accumulation appears to play a less pronounced role.
- JEL Code
- D91 : Microeconomics→Intertemporal Choice→Intertemporal Household Choice, Life Cycle Models and Saving
F36 : International Economics→International Finance→Financial Aspects of Economic Integration
F41 : International Economics→Macroeconomic Aspects of International Trade and Finance→Open Economy Macroeconomics