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http://hdl.handle.net/10419/66962
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| Title: | | Exchange rates and individual good's price misalignment: Some preliminary evidence of long-horizon predictability  |
| Authors: | | Dong, Wei Nam, Deokwoo |
| Issue Date: | | 2011 |
| Series/Report no.: | | Bank of Canada Discussion Paper 2011-8 |
| Abstract: | | When prices are sticky, movements in the nominal exchange rate have a direct impact on international relative prices. A relative price misalignment would trigger an adjustment in consumption and employment, and may help to predict future movements in the exchange rate. Although purchasing-power-parity fundamentals, in general, have only weak predictability, currency misalignment may be indicated by price differentials for some goods, which could then have predictive power for subsequent re-evaluation of the nominal exchange rate. The authors collect good-level price data to construct deviations from the law of one price and examine the resulting price-misalignment model's predictive power for the nominal exchange rates between the U.S. dollar and two other currencies: the Japanese yen and the U.K. pound. To account for small-sample bias and data-mining issues, inference is drawn from bootstrap distributions and tests of superior predictive ability (SPA) are performed. The slope coefficients and R-squares increase with the forecast horizon for the bilateral exchange rates between the U.S. dollar and the Japanese yen and the U.S. dollar and the U.K. pound. The out-of-sample SPA tests suggest that the authors' price-misalignment model outperforms random walks either with or without drift for the U.S. dollar vis-à-vis the Japanese yen at the 5 per cent level of significance over long horizons. |
| Subjects: | | Exchange rates International topics |
| JEL: | | F31 F47 |
| Document Type: | | Working Paper |
| Appears in Collections: | | Bank of Canada Discussion Papers
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