Investigating the Relevance of Meese-Rogoff Conclusion in Recent Models of Exchange-Rate Determination

Abstract

This paper examines the Messe and Rogoff claim of the superiority of random-walk model in the determination of exchange rate in the light of more recent models and empirical results. Random walk model is the traditional model of exchange rate determination while the recent models include the purchasing power parity (PPP), the monetary model and portfolio model. Empirical evidence against the dominance of random-walk in forecasting the behaviours of exchange rate seems to be large or rather inconclusive, since the main thrust of some of the findings is that Messe and Roggoff used out-of-sample test with shorter time horizon which does not have a good econometric justification. Although it cannot be absolutely concluded that economic models are useless in the determination of exchange rate, the relevance of a model in the determination of exchange rate depends on the combination of different factors which vary with time and place.

Keywords: Random walk, Exchange-Rate Determination Models, Meese and Rogoff Puzzle.