Pavlidis, E and Paya, I and Peel, D (2009) Forecasting the Real Exchange Rate using a Long Span of Data. A Rematch: Linear vs Nonlinear. Working Paper. The Department of Economics, Lancaster University.
This paper deals with the nonlinear modeling and forecasting of the dollar-sterling real exchange rate using a long span of data. Our contribution is threefold. First, we provide significant evidence of smooth transition dynamics in the series by employing a battery of recently developed in-sample statistical tests. Second, we investigate the small sample properties of several evaluation measures for comparing recursive forecasts when one of the competing models is nonlinear. Finally, we run a forecasting race for the post-Bretton Woods era between the nonlinear real exchange rate model, the random walk, and the linear autoregressive model. The winner turns out to be the nonlinear model, against the odds.
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