Modelling and forecasting the dollar-pound exchange rate in the presence of structural breaks

Jan 2019 | 866

Authors: Jennifer Castle Takamitsu Kurita

We employ a newly-developed partial cointegration system allowing for level shifts to examine whether economic fundamentals form the long-run determinants of the dollar-pound exchange rate in an era of structural change. The paper uncovers a class of local data generation mechanisms underlying long-run and short-run dynamic features of the exchange rate using a set of economic variables that explicitly reflect the central banks’ monetary policy stances and the influence of a forward exchange market. The impact of the Brexit referendum is evaluated by examining forecasts when the dollar-pound exchange rate fell substantially around the vote.

JEL Codes: C22, C32, C52, F31

Keywords: Exchange rates, Monetary policy, General-to-specific approach, Partial cointegrated vector autoregressive models, Structural breaks.

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