The predictive power of equilibrium exchange rate models

Arbeitspapier

In this paper we evaluate the predictive power of the three most popular equilibrium exchange rate concepts: Purchasing Power Parity (PPP), Behavioral Equilibrium Exchange Rate (BEER) and the Macroeconomic Balance (MB) approach. We show that there is a clear trade-off between storytelling and forecast accuracy. The PPP model offers little economic insights, but has good predictive power. The BEER framework, which links exchange rates to fundamentals, does not deliver forecasts of better quality than PPP. The MB approach has the most appealing economic interpretation, but performs poorly in forecasting terms. Sensitivity analysis confirms that changing the composition of fundamentals in the BEER model or modifying key underlying assumptions in the MB model does not generally enhance their predictive power.

Object Details

• ISBN: 978-92-899-4001-6
• Language: Englisch

References and Relationships

• Bibliographic citation: Series: ECB Working Paper ; No. 2358

Classification and Topics

• Classification: Wirtschaft ; Multiple or Simultaneous Equation Models: Panel Data Models; Spatio-temporal Models ; Foreign Exchange ; International Finance Forecasting and Simulation: Models and Applications ; Open Economy Macroeconomics
• Subject: Equilibrium exchange rate models ; mean reversion ; forecasting ; panel data

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Ca' Zorzi, Michele ; Cap, Adam ; Mijakovic, Andrej ; Rubaszek, Michał
• Event: Veröffentlichung
• (who): European Central Bank (ECB)
• (where): Frankfurt a. M.
• (when): 2020

Further information

• DOI: doi:10.2866/927929
• Handle: http://hdl.handle.net/10419/228236
• Last update: 10.03.2025, 11:42 AM CET