Exchange rate forecasting with DSGE models

Michele Ca' Zorzi, Marcin Kolasa and Michał Rubaszek

No 1905, Working Paper Series from European Central Bank

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 Classification: C32, F31, F37

Keywords: exchange rates; forecasting; mean reversion; new open economy macroeconomics (search for similar items in EconPapers)
Date: 2016-05
New Economics Papers: this item is included in nep-dge, nep-for, nep-mon and nep-opm
Note: 343031
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Citations: View citations in EconPapers (8)

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Related works:
Journal Article: Exchange rate forecasting with DSGE models (2017)
Working Paper: Exchange rate forecasting with DSGE models (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20161905

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