Exchange Rate Economics: Theories and Evidence

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Empirical evidence on the monetary approach 153 generating process,should do better than a static model or one with very simple dynamics (which is essentially the kind of model used by other researchers). MacDonald and Marsh focus on the yen,mark and pound against the US dollar, over the period January 1974–December 1992,with the last 24 observations held back for forecasting purposes. The forecasts constructed are fully simultaneous and dynamic and could therefore have been used by a potential forecaster. The success of the forecasts is gauged in three ways. First,using the RMSE r criterion, discussed earlier. Second,in terms of the directional ability calculated as: D = (1 if forecast direction = actual,else 0) . (6.33) n On the basis of chance D is expected to be 0.5,and therefore any number above 0.5 means that the model does better in terms of its predictive ability than simply tossing a coin. Finally,RMSE ratios were constructed for the model projections relative to a panel of 150 professional forecasts,located in the G7 financial centres, and as collected by Consensus Economics of London (gauged using the RMSE r criterion). In Table 6.5 we present a representative SEM model for the UK–USD. This table should be read in the following way. The dependent variable for each equation is noted in the first column (so,for example,the first equation is for the change in the exchange rate). The cells in the columns under A 0 contain contemporaneous (i.e. period t) interactions amongst the variables,while the cells in the A i block contain the coefficients on the lagged variables. Finally,the coefficients on the ECM terms (i.e. the α coefficients) are contained in the final two columns. The estimated system reported in Table 6.5 reveals that there are a number of significant simultaneous interactions,complex dynamic relationships that drive the dependent variables and also the importance of the error correction terms which are numerous and also highly significant in all cases. The forecasting results are summarised in Table 6.6. We note that for the pound sterling the model beats the random walk at 2 months ahead,while for the yen and mark forecastability kicks in at 3 and 4 months ahead,respectively. Note that many of the RMSE ratios are significantly less than unity and this is especially so for the pound sterling. All of the models seem to have very good directional forecasting powers and across the three currencies and forecast horizons,our models outperform the professional forecasters. It is also worth noting that the RMSE ratio of our SEM model relative to a VAR in first differences is always less than unity. This would seem to underscore the point that such models are likely to underperform,both because they are over-parameterised and also because of their failure to incorporate the ‘long-run’ information contained in the cointegrating vector. In a follow-up paper,MacDonald and Marsh (1999) extend their earlier analysis by using a tripolar model of the yen,dollar and German mark (the long-run relationships for this model are discussed in Chapter 9). An example of one of the
Table 6.5 SEM equations: United Kingdom A0 Ai A St pt p ∗ t it i ∗ t pt−1 pt−3 p ∗ t−1 i t−1 i ∗ t−1 i ∗ t−2 i ∗ t−3 i ∗ t−4 ECM 1t−1 ECM 2t−1 st −1 — −5.541 2.959 — — — — — — — — — — −0.076 (3.826) (3.354) (4.410) pt −0.119 −1 — 0.433 −0.551 0.266 0.157 — — — — — — −0.006 — (3.014) (2.508) (2.304) (4.734) (3.006) (6.104) p t ∗ 0.053 0.097 −1 — — — — 0.646 — — — 0.125 — — — (2.930) (2.193) (9.426) (2.928) it — — — −1 0.441 0.122 — — 0.362 — — — — 0.007 −0.010 (2.684) (2.254) (6.036) (5.744) (4.178) i t ∗ — — 0.476 — −1 — — — — 0.195 −0.297 — −0.124 — — (4.047) (2.929) (4.324) (1.949) Source: MacDonald and Marsh (1997).
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Exchange Rate Economics Exchange Ra
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Firstpublished2007 by Routledge 2Pa
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Contents List of figures List of ta
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Figures 1.1 The balance of payments
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Figures 13.6 Fourth generation spec
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Preface This book is the second edi
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2 Introduction Although the textboo
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4 Introduction (orders to buy/sell
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6 Introduction Table 1.3 Currency d
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8 Introduction a truly flexible exc
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10 Introduction this has to be sati
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12 Introduction likely that the rel
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14 Introduction or F (1 + i) = S (1
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16 Introduction Consider now a fall
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18 Introduction The empirical evide
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20 Introduction (mean and variance)
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22 Introduction (a) (b) 0.3 0.25 0.
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24 Introduction clusters or that it
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26 Introduction 0.1 0.05 0 -0.05 -0
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28 Introduction 1.9 Exchange rate r
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30 Introduction fixed versus flexib
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32 Introduction influences. For exa
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34 Introduction 1.11 The determinan
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36 Introduction In the standard OCA
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38 Introduction most transactions i
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40 Purchasing power parity and the
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3 The economics of the PPP puzzle I
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70 The economics of the PPP puzzle
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4 The flexible price monetary appro
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96 The flexible price monetary appr
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98 The flexible price monetary appr
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100 The flexible price monetary app
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Page 151 and 152: 136 Empirical evidence on the monet
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Page 181 and 182: 7 Currencysubstitution models and t
Page 183 and 184: 168 Currency substitution and portf
Page 215 and 216: 200 Real exchange rate determinatio
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204 Real exchange rate determinatio
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228 Equilibrium exchange rates rate
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230 Equilibrium exchange rates A nu
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232 Equilibrium exchange rates long
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234 Equilibrium exchange rates 5.1
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236 Equilibrium exchange rates term
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238 Equilibrium exchange rates 0.30
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240 Equilibrium exchange rates Detk
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242 Equilibrium exchange rates US i
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244 Equilibrium exchange rates The
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246 Equilibrium exchange rates 9.6.
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248 Equilibrium exchange rates 9.6.
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250 Equilibrium exchange rates Conc
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252 The new open economy macroecono
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11 The new open economy macroeconom
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290 Target zone models 12.1 The bas
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292 Target zone models stochastic c
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294 Target zone models moves from 2
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296 Target zone models where A 1 an
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298 Target zone models expected dev
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300 Target zone models % expected d
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302 Target zone models MacDonald (2
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304 Target zone models for the DM-l
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306 Target zone models explicit ban
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308 Target zone models Table 12.1 F
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310 Target zone models short-term i
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312 Target zone models the UK short
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314 Speculative attack models and c
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340 Market microstructure approach
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15 Spot and forward exchange rates
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Notes 1 Introduction: some basic co
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398 Notes 4 Although the split betw
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400 Notes 3 The fact that the utili
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402 Notes 15 This result is familia
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404 Notes 6 Where ∫ ∞ vg(v) E(v
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406 References Artis,M. and M. Lewi
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408 References Bergin,P.,R. Glick a
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410 References Calvo,G.A. and C.A.
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412 References Clark,P.B. and R. Ma
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414 References Detken,C.,A. Dieppe,
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416 References Edwards,S. and I. Ma
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418 References Fischer,S. (2001),
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420 References Frieden,J.P.G. and E
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422 References Granger,C.W. and T.
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424 References Hooper,P. and J. Mor
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426 References Kearney,C. and R. Ma
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428 References Lewis,K. (1988),‘T
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430 References MacDonald,R. (2002),
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432 References Mark,N.C. (2001),Int
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434 References Obstfeld,M. and K. R
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436 References Roll,R. (1979),‘Vi
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438 References Tauchen,G.E. and M.
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Index Abadir,K. 389 Abuaf,N. 60 Adl
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442 Index Diba,B. 177-8 Dickey,D.A.
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444 Index Gagnon,J. 212 Gali,J. 128
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446 Index Miller,M.H. 120,123,128,1
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448 Index purchasing power parity (
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450 Index trade: interbank trade 34
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Exchange Rate Economics: Theories and Evidence

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