Balassa-Samuelson Theory and Predictability of the US/UK Real Exchange Rate

Kim Chung-Han

International Economic Journal, 2000, vol. 14, issue 3, 101-121

Abstract: This paper performs a theory-based forecast of the US/UK real exchange rate. The theory is the Balassa-Samuelson hypothesis that productivity differentials between two countries would determine long-run movements of real exchange rates. The relative income and real exchange rate set a bivariate system, which considers the heteroskedasticity in the real exchange rate movements. The model, to which the Kalman filter and Markov-switching algorithm are applied, is compared with the random walk model and reports significant improvements in forecasting in the medium and long term. [C53, F31]

Date: 2000
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DOI: 10.1080/10168730000000031

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