(EURO) Exchange Rate Predictability and Monetary Fundamentals in a Small Multi-Country Panel

In this paper a panel of vector error correction models based on a common long-run relationship is utilized to test whether the DM exchange rates of Canada, Japan and the United States comply in the long-run with a rational expectations-based monetary exchange rate model. Compared to existing coin-tegration frameworks our approach indicates that the aforementioned exchange rates are indeed consis-tent with the monetary exchange rate model based on a common long-run relationship. We also analyze the out-of-sample fit of this common long-run exchange rate model relative to naive random walk-based forecasts through several forecasting evaluation measures. These forecasting evaluations indicate that the monetary model-based common long-run model is superior to both random walk-based forecasts and standard cointegrated VAR model-based forecasts.