Tài liệu The importance of interest rates for forecasting the exchange rate doc

Discussion Papers No. 340, February 2003

Statistics Norway, Research Department

Hilde C. Bjørnland and Håvard Hungnes

The importance of interest rates

for forecasting the exchange rate

Abstract:

This study compares the forecasting performance of a structural exchange rate model that combines

the purchasing power parity condition with the interest rate differential in the long run, with some

alternative models. The analysis is applied to the Norwegian exchange rate. The long run equilibrium

relationship is embedded in a parsimonious representation for the exchange rate. The structural

exchange rate representation is stable over the sample and outperforms a random walk in an out-of￾sample forecasting exercise at one to four horizons. Ignoring the interest rate differential in the long

run, however, the structural model no longer outperforms a random walk.

Keywords: Equilibrium real exchange rate, cointegration VAR, out-of-sample forecasting

JEL classification: C22, C32, C53, F31

Acknowledgement: The authors wish to thank Å. Cappelen, P. R. Johansen and T. Skjerpen for

very useful comments and discussions. The usual disclaimers apply.

Address: Hilde C. Bjørnland, University of Oslo and Statistics Norway.

E-mail: [email protected].

Håvard Hungnes, Statistics Norway, Research Department. E-mail: [email protected]

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