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Seoul Journal of Economics
[ Article ]
Seoul Journal of Economics - Vol. 24, No. 3, pp.333-355
ISSN: 1225-0279 (Print)
Print publication date 31 Aug 2011
Received 29 Jun 2010 Revised 17 Feb 2011 Accepted 07 Mar 2011

Hysteresis and Averaging the Forecasts of Exchange Rates

Byeongseon Seo ; Jinho Kim
Corresponding Author, Professor, Department of Food and Resource Economics, Korea University, Anam-Dong, Seongbuk-Ku, Seoul 136-701, Korea, Tel: +82-2-3290-3032, Fax: +82-2-953-0737 seomatteo@korea.ac.kr
Graduate Student, Department of Food and Resource Economics, Korea University, Anam-Dong, Seongbuk-Ku, Seoul 136-701, Korea, Tel: +82-2-958-4088 lyankim007@korea.ac.kr

JEL Classification: C53, F31, F37, G17

Abstract

Real exchange rates evolve independently of money supply shocks in accordance with long-run monetary neutrality. However, the prolonged disequilibrium errors of the Korean won―US dollar real exchange rates in the 1990s prior to the Asian financial crisis and the hike subsequent to the crisis indicate hysteresis of the real exchange rates. The hysteresis may originate from two sources, namely, the instability of the equilibrium relationship and the regime-dependent persistence of real exchange rates. The current paper provides a statistical evaluation of the hysteresis in the won―dollar real exchange rates using forecast combination. The behavior of asymmetric mean reversion and regime-dependent persistence dominates the parameter instability in real exchange rates. A substantial improvement in predictive accuracy is observed as the forecasting model incorporates the hysteresis effect.

Keywords:

Forecast combination, Hysteresis, Instability, Persistence

Acknowledgments

The authors thank M. Fukushige, H. Pyo, K. Shin, C. Song, and the participants at the annual conference of Japan Society of International Economics for their invaluable comments and suggestions. Special thanks go to the anonymous referees and the Editor for the useful comments and suggestions. This work was supported by the National Research Foundation of Korea Grant funded by the Korean Government (NRF-2010-330-B00060).

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