nep-for New Economics Papers
on Forecasting
Issue of 2009‒10‒03
two papers chosen by
Rob J Hyndman
Monash University

  1. Can long-horizon forecasts beat the random walk under the Engel-West explanation? By Charles Engel; Jian Wang; Jason Wu
  2. Can behavioral finance models account for historical asset prices? By ap Gwilym, Rhys

  1. By: Charles Engel; Jian Wang; Jason Wu
    Abstract: Engel and West (EW, 2005) argue that as the discount factor gets closer to one, present-value asset pricing models place greater weight on future fundamentals. Consequently, current fundamentals have very weak forecasting power and exchange rates appear to follow approximately a random walk. We connect the Engel-West explanation to the studies of exchange rates with long-horizon regressions. We find that under EW's assumption that fundamentals are I(1) and observable to the econometrician, long-horizon regressions generally do not have significant forecasting power. However, when EW's assumptions are violated in a particular way, our analytical results show that there can be substantial power improvements for long-horizon regressions, even if the power of the corresponding shorthorizon regression is low. We simulate population Rsquared for long-horizon regressions in the latter setting, using Monetary and Taylor Rule models of exchange rates calibrated to the data. Simulations show that long-horizon regression can have substantial forecasting power for exchange rates.
    Keywords: Foreign exchange rates ; Financial markets ; Asset pricing ; Forecasting ; Random walks (Mathematics) ; Regression analysis
    Date: 2009
  2. By: ap Gwilym, Rhys
    Abstract: I construct a behavioral model of asset pricing in which agents choose whether to base their expectations on chartist or fundamental forecasts. I simulate the model in order to test its efficacy in explaining the moments and time series properties of the FTSE All-Share index, and find that the model cannot be rejected as the data generating process.
    Keywords: Behavioral finance; Asset pricing
    JEL: G12
    Date: 2009–09

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