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Model Uncertainty of Real Exchange Rate Forecast over Mid-term Horizons*1

December 2001
Munehisa Kasuya
Izumi Takagawa

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We investigate the significance of fundamentals variables and uncertainty of appropriate models in one-, two-, four-, and eight-quarter ahead forecasts of quarterly yen-dollar real exchange rates by using 16 fundamentals-based models and the random walk model. Our empirical results show significance of fundamentals variables in two-, four-, and eight-quarter ahead forecasts. Moreover, the reversible jump MCMC approach for uncertainty of appropriate models indicates that appropriate models change over both forecast-time-span and forecast period. This uncertainty could not be fully explained by the hypothesis that real exchange rates are ultimately governed by the true fundamentals-based model.

Exchange rates, Fundamentals, Prediction, Reversible Jump, Markov Chain Monte Carlo

JEL Classification:
F31, F37, F47

  • *1 The authors would like to thank Mitsuhiro Fukao, Shinichi Fukuda, Keiichi Hori, Masao Ogaki, Toshiaki Watanabe, participants of the Society of Applied Economic Time Series Analysis in 2001 and the 2001 Japan Economic Conference, and staff of the Bank of Japan for their helpful comments and suggestions. Views expressed in this paper are those of authors and do not necessarily reflect those of the Bank of Japan or the Research and Statistics Department.