A Consumption-Based Approach to Exchange Rate Predictability
La serie Borradores de Economía es una publicación de la Subgerencia de Estudios Económicos del Banco de la República. Los trabajos son de carácter provisional, las opiniones y posibles errores son responsabilidad exclusiva del autor y sus contenidos no comprometen al Banco de la República ni a su Junta Directiva.
This paper provides evidence of short-run predictability for the real exchange rate by performing out-of-sample tests of a forecasting equation which is derived from a consumption-based asset pricing model. In this model, the real exchange rate is predictable as a result of the implications of preferences with habit persistence on the pricing of international assets. The implied predictors are: domestic, US and world consumption growth. Empirical exercises show evidence of short-term predictability on the bilateral rates of 15 out of 17 countries vis-à-vis the US over the post Bretton-Woods float. A GMM estimation of the parameters of the model also finds evidence of the presence of habits in consumers’ preferences.
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