MEAN REVERSION IN REAL EXCHANGE-RATES - EVIDENCE AND IMPLICATIONS FORFORECASTING

The stationarity of real exchange rates over the recent flexible excha nge rate period is an issue that has long bedeviled researchers in int ernational finance. Using a constrained multivariate framework, this p aper provides the strongest evidence yet that real exchange rates were mean-reverting over the 1973-93 period. We also investigate shifts in long-run real exchange rates, which may be important for the purpose of forecasting. Out-of-sample forecasting shows that the random walk m odel is outperformed by a mean-stationary model, especially at long ho rizons. In addition, there are substantial forecasting benefits from u sing a multivariate approach. (JEL C22, F21). Copyright (C) 1996 Elsev ier Science Ltd