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324
Order Flow and Exchange Rate Dynamics
, 1999
"... Macroeconomic models of nominal exchange rates perform poorly. In sample, R 2 statistics as high as 10 percent are rare. Out of sample, these models are typically outforecast by a naïve random walk. This paper presents a model of a new kind. Instead of relying exclusively on macroeconomic determina ..."
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Cited by 303 (23 self)
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Macroeconomic models of nominal exchange rates perform poorly. In sample, R 2 statistics as high as 10 percent are rare. Out of sample, these models are typically outforecast by a naïve random walk. This paper presents a model of a new kind. Instead of relying exclusively on macroeconomic determinants, the model includes a determinant from the field of microstructureorder flow. Order flow is the proximate determinant of price in all microstructure models. This is a radically different approach to exchange rate determination. It is also strikingly successful in accounting for realized rates. Our model of daily exchangerate changes produces R 2 statistics above 50 percent. Out of sample, our model produces significantly better shorthorizon forecasts than a random walk. For the DM/ $ spot market as a whole, we find that $1 billion of net dollar purchases increases the DM price of a dollar by about 1 pfennig. eScholarship provides open access, scholarly publishing services to the University of California and delivers a dynamic
Why is it so Difficult to Beat the Random Walk Forecast of Exchange Rates
 Journal of International Economics
, 2003
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The Purchasing Power Parity Debate
 Journal of Economic Perspectives
, 2004
"... Our willingness to pay a certain price for foreign money must ultimately and essentially be due to the fact that this money possesses a purchasing power as against commodities and services in that country. On the other hand, when we offer so and so much of our own money, we are actually offering a p ..."
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Cited by 124 (11 self)
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Our willingness to pay a certain price for foreign money must ultimately and essentially be due to the fact that this money possesses a purchasing power as against commodities and services in that country. On the other hand, when we offer so and so much of our own money, we are actually offering a purchasing power as against commodities and services in our own country. Our valuation of a foreign currency in terms of our own, therefore, mainly depends on the relative purchasing power of the two currencies in their respective countries. Gustav Cassel, economist (1922, pp. 138–39) The fundamental things apply As time goes by. Herman Hupfeld, songwriter (1931; from the film Casablanca, 1942) P urchasing power parity (PPP) is a disarmingly simple theory that holds thatthe nominal exchange rate between two currencies should be equal to theratio of aggregate price levels between the two countries, so that a unit of currency of one country will have the same purchasing power in a foreign country. The PPP theory has a long history in economics, dating back several centuries, but the specific terminology of purchasing power parity was introduced in the years
Using OutofSample Mean Squared Prediction Errors to Test the Martingale Difference Hypothesis
, 2004
"... We consider using outofsample mean squared prediction errors (MSPEs) to evaluate the null that a given series follows a zero mean martingale difference against the alternative that it is linearly predictable. Under the null of no predictability, the population MSPE of the null “no change” model eq ..."
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Cited by 119 (14 self)
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We consider using outofsample mean squared prediction errors (MSPEs) to evaluate the null that a given series follows a zero mean martingale difference against the alternative that it is linearly predictable. Under the null of no predictability, the population MSPE of the null “no change” model equals that of the linear alternative. We show analytically and via simulations that despite this equality, the alternative model’s sample MSPE is expected to be greater than the null’s. For rolling regression estimators of the alternative model’s parameters, we propose and evaluate an asymptotically normal test that properly accounts for the upward shift of the sample MSPE of the alternative model. Our simulations indicate that our proposed procedure works well.
Macroeconomic Fluctuations in Developing Countries: Some Stylized Facts
 Economic Development Institute, World Bank, Washington, D.C. Processed. Online at http:// www.worldbank.org/html/edi/ediwp.htm
, 1998
"... This article documents the main stylized features of macroeconomic fluctuations for 12 developing countries. It presents crosscorrelations between domestic industrial output and a large group of macroeconomic variables, including fiscal variables, wages, inflation, money, credit, trade, and exchan ..."
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Cited by 105 (13 self)
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This article documents the main stylized features of macroeconomic fluctuations for 12 developing countries. It presents crosscorrelations between domestic industrial output and a large group of macroeconomic variables, including fiscal variables, wages, inflation, money, credit, trade, and exchange rates. Also analyzed are the effects of economic conditions in industrial countries on output fluctuations in the sample developing countries. The results point to many similarities between macroeconomic fluctuations in developing and industrial countries (procyclical real wages, countercyclical variation in government expenditures) and some important differences (countercyclical variation m the velocity of monetary aggregates). Their robustness is examined using different detrending procedures. Understanding and distinguishing among the factors that affect the short and longrun behavior of macroeconomic time series have been among the main areas of recent research in quantitative macroeconomic analysis. Using a variety of econometric techniques, a substantial body of literature has documented a wide range of empirical regularities in macroeconomic fluctuations and business cycles
The OutofSample Success of Term Structure Models as Exchange Rate Predictors: A Step Beyond
, 2001
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Towards a solution to the puzzles in exchange rate economics: where do we stand?, Canadian
 Journal of Economics
, 2005
"... This paper provides a selective overview of puzzles in exchange rate economics. We begin with the forward bias puzzle: high interest rate currencies appreciate when one might guess that investors would demand higher interest rates on currencies expected to fall in value. We then analyze the purchasi ..."
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Cited by 82 (2 self)
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This paper provides a selective overview of puzzles in exchange rate economics. We begin with the forward bias puzzle: high interest rate currencies appreciate when one might guess that investors would demand higher interest rates on currencies expected to fall in value. We then analyze the purchasing power parity puzzle: the real exchange rate displays no (strong) reversion to a stable longrun equilibrium level. Finally, we cover the exchange rate disconnect puzzle: the lack of a link between the nominal exchange rate and economic fundamentals. For each puzzle, we critically review the literature and speculate on potential solutions. JEL classification: F31.
Exchange Rate Models Are Not as Bad as You Think
 NBER MACROECONOMICS ANNUAL
, 2007
"... Standard models of exchange rates, based on macroeconomic variables such as prices, interest rates, output, etc., are thought by many researchers to have failed empirically. We present evidence to the contrary. First, we emphasize the point that “beating a random walk” in forecasting is too strong a ..."
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Cited by 52 (4 self)
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Standard models of exchange rates, based on macroeconomic variables such as prices, interest rates, output, etc., are thought by many researchers to have failed empirically. We present evidence to the contrary. First, we emphasize the point that “beating a random walk” in forecasting is too strong a criterion for accepting an exchange rate model. Typically models should have low forecasting power of this type. We then propose a number of alternative ways to evaluate models. We examine insample fit, but emphasize the importance of the monetary policy rule, and its effects on expectations, in determining exchange rates. Next we present evidence that exchange rates incorporate news about future macroeconomic fundamentals, as the models imply. We demonstrate that the models might well be able to account for observed exchangerate volatility. We discuss studies that examine the response of exchange rates to announcements of economic data. Then we present estimates of exchangerate models in which expected present values of fundamentals are calculated from survey forecasts. Finally, we show that outofsample forecasting power of models can be increased by focusing on panel estimation and longhorizon forecasts.