Model instability in predictive exchange rate regressions

Hauzenberger, Niko and Huber, Florian ORCID: https://orcid.org/0000-0002-2896-7921 (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: 02 Sep 2020 15:19
URI: https://epub.wu.ac.at/id/eprint/6770

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