The value of the dollar appears to move in one direction for long periods
of time. We develop a new statistical model of exchange rate dynamics as a
sequence of stochastic, segmented time trends. The paper implements new
techniques for parameter estimation and hypothesis testing for this framework.
We reject the null hypothesis that exchange rates follow a random walk in
favor of our model of long swings. Our model also generates better forecasts
than a random walk. We conclude that persistent movement in the value of the
dollar is a fact that calls for greater attention in the theory of exchange
rate behavior.
The model is a natural framework for assessing the importance of the
"peso problem" for the dollar. It allows for the expectation of future
exchange rates to be influenced by the probability of a change in regime. We
nonetheless reject uncovered interest parity. The forward premium appears
frequently to put too high a probability on a change in regime.
*Published:
"Long Swings in the Dollar: Are they in the Data and Do Markets Know It?" American Economic Review, Volume 80, September 1990, 689-713
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