Forecasting the Taylor rule exchange rate model using directional change tests

Rudan Wang, Bruce Morley

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Abstract

This study uses the Taylor rule model of exchange rate determination, to analyse how accurately it can predict directional changes in the exchange rate. Using bilateral exchange rate data for the US, UK, Sweden and Australia, we conduct the Pesaran-Timmermann test to determine how accurately this model can forecast changes in direction. The results suggest that although in many studies the standard out-of-sample forecasting ability of this model has been successful, the performance of the change of direction predictions are not consistently accurate over all specifications tested, in which case they may not prove profitable in a trading environment.
Original languageEnglish
Article number3
Pages (from-to)931-951
Number of pages20
JournalQuantitative Finance and Economics
Volume2
Issue number4
DOIs
Publication statusPublished - 3 Dec 2018

Keywords

  • Forecast; Taylor rule; Exchange rate; Prediction accuracy.

ASJC Scopus subject areas

  • Economics, Econometrics and Finance(all)

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