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Forecasting the Taylor rule exchange rate model using directional change tests

1 Coventry University, UK
2 Department of Economics, University of Bath, Bath, UK, BA2 7AY

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.
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Keywords forecast; Taylor rule; exchange rate; prediction accuracy

Citation: Rudan Wang, Bruce Morley. Forecasting the Taylor rule exchange rate model using directional change tests. Quantitative Finance and Economics, 2018, 2(4): 931-951. doi: 10.3934/QFE.2018.4.931


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