Exchange Rate Forecasting Using Uncovered Return Parity - Ncube, Michael M (University of the Witwatersrand, Johannesburg, 2024)
This paper presents a unified exchange rate model of exchange rate determination and forecasting using the Monteary Fundamentals, the Taylor Rule Fundamentals as well as the return differentials of a portfolio composed of money market instruments, bonds, and equity market returns. We use the simple OLS estimation technique for the estimation and a recursive rolling regression technique to generate the out-of-sample forecasts. The out-of-sample forecast analysis, using the Mean Absolute Error (MAE), Root Mean Squared Error (RMSE), Mean Squared Prediction Error (MSPE), and the Theil U2 coefficient statistic for model statistic suggests that our unified forecasting exchange rate model outperforms the naïve random walk model in forecasting one- month nominal exchange rates for all the countries in the study. The results also show that the unified forecasting exchange rate model is also able to outperform the Taylor Rule Fundamentals for 13 out of 14 of the countries at one month ahead forecasting horizon. These findings imply that the combination of the Taylor Rule Fundamentals, as well as the three market variables in modelling exchange rates, improves the forecasting ability of exchange rate models
Keywords: Exchange Rate Forecasting; Uncovered Return Parity; UCTD; SDG-8: Decent work and economic growth