Exchange rate predictability and a monetary model with time-varying cointegration coefficients

Cheolbeom Park, Sookyung Park

Research output: Contribution to journalArticle

15 Citations (Scopus)

Abstract

Many studies have pointed out that the underlying relations and functions for the monetary model (e.g. the PPP relation, the money-demand function, monetary policy rule, etc.) have undergone parameter instabilities and that the relation between exchange rates and macro fundamentals is unstable due to the shift in the economic models in foreign exchange traders' views or the scapegoat effect in Bacchetta and van Wincoop (2009). Facing this, we consider a monetary model with time-varying cointegration coefficients in order to understand exchange rate movements. Weprovide statistical evidence against the standard monetary model with constant cointegration coefficients but find favorable evidence for the time-varying cointegration relationship between exchange rates and monetary fundamentals. Furthermore, we demonstrate that deviations between the exchange rate and fundamentals from the time-varying cointegration relation have strong predictive power for future changes in exchange rates through in-sample analysis, out-of-sample analysis, and directional accuracy tests.

Original languageEnglish
Pages (from-to)394-410
Number of pages17
JournalJournal of International Money and Finance
Volume37
DOIs
Publication statusPublished - 2013

Keywords

  • Exchange rate
  • Monetary model
  • Predictability
  • Time-varying cointegration

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics

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