An eclectic view on the euro/dollar exchange rate
Dieter Nautz and Jan Scheithauer∗
April 15, 2005
Abstract
Empirical exchange rate analysis is usually based on a specific exchange rate
theory emphasizing the impact of a few key fundamentals. This paper investigates
the usefulness of an eclectic view on the exchange rate covering different theories.
Automatic econometric model selection is employed to obtain a parsimonious ex-
change rate equation suited for forecasting purposes. Our results obtained for the
euro/dollar exchange rate indicate that incorporating more fundamentals in the
empirical analysis does not necessarily improve the forecasting performance of ex-
change rate equations. The evaluation of out-of-sample forecasts shows that the
eclectic exchange rate equation is outperformed by an equation that restricts the
attention to monetary fundamentals.
JEL codes: F31; E47
Keywords: Euro/Dollar exchange rate, behavioral equilibrium exchange rate model,
monetary exchange rate model, automatic econometric model selection
∗Department of Money and Macro, Goethe University Frankfurt. E-mail: nautz@wiwi.uni-
frankfurt.de; scheitha@wiwi.uni-frankfurt.de
1
2
1 Introduction
Since Meese and Rogoff (1983) documented the discouraging forecasting performance
of exchange rate models, a large part of exchange rate economics has aimed at find-
ing empirical support for numerous exchange rate conceptions including the monetary
exchange rate model, the portfolio balance approach or, more recently, the behavioral
equilibrium exchange rate (BEER) models. Yet empirical evidence supporting these
models has remained elusive, see e.g. Cheung et al. (2002).
Different exchange rate theories usually emphasize the importance of different economic
fundamentals. According to Dornbusch (1980) these models can thus be regarded as
partial views on the exchange rate. So far, few attempts have been made to integrate
the various models in empirical analysis to get a more complete picture of exchange
rate determination. The current paper inv