The unbeatable random walk in exchange rate forecasting: Reality or myth?
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It is demonstrated that the conventional monetary model of exchange rates can (irrespective of the specification, estimation method or the forecasting horizon) outperform the random walk in out-of-sample forecasting if forecasting power is measured by direction accuracy and profitability. Claims of outperforming the random walk in terms of the root mean square error are false because they are typically based on the introduction of dynamics, hence a random walk component, commonly without testing for the statistical significance of the difference between root mean square errors. And even if proper hypothesis testing reveals that a dynamic model outperforms the random walk, this amounts to beating the random walk by a random walk with the help of some explanatory variables. The failure of conventional macroeconomic models to outperform the random walk in terms of the root mean square error should be expected rather than considered to be a puzzle.
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Moosa, I.; Burns, Kelly (2015)The Messe-Rogoff puzzle has been a debatable topic since 1983 when Richard Meese and Kenneth Rogoff demonstrated that no exchange rate model can outperform the random walk in out-of-sample forecasting. This finding been ...
Error correction modelling and dynamic specifications as a conduit to outperforming the random walk in exchange rate forecastingMoosa, I.; Burns, Kelly (2014)The proposition that dynamic exchange rate models can outperform the random walk in out-of-sample forecasting, in the sense that they produce lower mean square errors, is examined and disputed. By using several dynamic ...
Burns, Kelly; Moosa, I. (2017)Structural breaks have been suggested by several economists as a possible explanation for the Meese–Rogoff puzzle, in the sense that an exchange rate model can outperform the random walk in terms of the out-of-sample ...