Empirical Economics

, Volume 43, Issue 1, pp 399–426 | Cite as

Understanding forecast failure of ESTAR models of real exchange rates

Article

Abstract

The forecast performance of the empirical ESTAR model of Taylor et al. (2001) is examined for 4 bilateral real exchange rate series over an out-of-sample evaluation period of nearly 12 years. Point as well as density forecasts are constructed, considering forecast horizons of 1 to 22 steps head. The study finds that no forecast gains over a simple AR(1) specification exist at any of the forecast horizons that are considered, regardless of whether point or density forecasts are utilised in the evaluation. Non-parametric methods are used in conjunction with simulation techniques to learn about the models and their forecasts. It is shown graphically that the nonlinearity in the conditional means (or point forecasts) of the ESTAR model decreases as the forecast horizon increases. The non-parametric methods show also that the multiple steps ahead forecast densities are normal looking with no signs of bi-modality, skewness or kurtosis.

Keywords

Purchasing power parity Regime modelling Non-linear real exchange rate models ESTAR Forecast evaluation Density forecasts Non-parametric methods 

JEL Classification

C22 C52 C53 F31 F47 

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Copyright information

© Springer-Verlag 2011

Authors and Affiliations

  1. 1.University of St. Gallen, Institute of Mathematics and StatisticsSt. GallenSwitzerland

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