Exchange Rate Predictability: Evidence from Canada

Abstract

Exchange rate forecasting has proven to be a difficult task, specifically in terms of the Meese and Rogoff puzzle. The fundamental question that I address is: which model best forecasts changes in the nominal exchange rate, a macroeconomic model or a random walk with drift? I use the ordinary least square method to estimate several macroeconomic models of bilateral exchange rates, and then I compare the ability of the macroeconomic models to forecast movements in the exchange rate to that of the random walk using data at the daily frequency. I use measures of forecast error and directional accuracy to evaluate the models. I find that the macroeconomic model outperforms the benchmark for the exchange rates between the Canadian Dollar and the currencies of the United Kingdom, Japan, Korea and the United States.