Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/228236
Authors: 
Ca' Zorzi, Michele
Cap, Adam
Mijakovic, Andrej
Rubaszek, Michał
Year of Publication: 
2020
Series/Report no.: 
ECB Working Paper No. 2358
Abstract: 
In this paper we evaluate the predictive power of the three most popular equilibrium exchange rate concepts: Purchasing Power Parity (PPP), Behavioral Equilibrium Exchange Rate (BEER) and the Macroeconomic Balance (MB) approach. We show that there is a clear trade-off between storytelling and forecast accuracy. The PPP model offers little economic insights, but has good predictive power. The BEER framework, which links exchange rates to fundamentals, does not deliver forecasts of better quality than PPP. The MB approach has the most appealing economic interpretation, but performs poorly in forecasting terms. Sensitivity analysis confirms that changing the composition of fundamentals in the BEER model or modifying key underlying assumptions in the MB model does not generally enhance their predictive power.
Subjects: 
Equilibrium exchange rate models
mean reversion
forecasting
panel data
JEL: 
C33
F31
F37
F41
Persistent Identifier of the first edition: 
ISBN: 
978-92-899-4001-6
Document Type: 
Working Paper

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