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Model instability in predictive exchange rate regressions

Hauzenberger, Niko and Huber, Florian (2018) Model instability in predictive exchange rate regressions. Department of Economics Working Paper Series, 276. WU Vienna University of Economics and Business, Vienna.

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Abstract

In this paper we aim to improve existing empirical exchange rate models by accounting for uncertainty with respect to the underlying structural representation. Within a flexible Bayesian non-linear time series framework, our modeling approach assumes that different regimes are characterized by commonly used structural exchange rate models, with their evolution being driven by a Markov process. We assume a time-varying transition probability matrix with transition probabilities depending on a measure of the monetary policy stance of the central bank at the home and foreign country. We apply this model to a set of eight exchange rates against the US dollar. In a forecasting exercise, we show that model evidence varies over time and a model approach that takes this empirical evidence seriously yields improvements in accuracy of density forecasts for most currency pairs considered.

Item Type: Paper
Keywords: Empirical exchange rate models, exchange rate fundamentals, Markov switching
Classification Codes: JEL C30, E32, E52, F31
Divisions: Departments > Volkswirtschaft
Depositing User: Claudia Tering-Raunig
Date Deposited: 10 Jan 2019 08:41
Last Modified: 10 Jan 2019 08:41
URI: http://epub.wu.ac.at/id/eprint/6770

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