Exchange Rate Predictability

The main goal of this article is to provide an answer to the question: Does any-thing forecast exchange rates, and if so, which variables?. It is well known that exchange rate uctuations are very di ¢ cult to predict using economic models, and that a random walk forecasts exchange rates better than any economic model (the Meese and Rogo ¤ puzzle). However, the recent literature has identi\u85ed a series of fun-damentals/methodologies that claim to have resolved the puzzle. This article provides a critical review of the recent literature on exchange rate forecasting and illustrates the new methodologies and fundamentals that have been recently proposed in an up-to-date, thorough empirical analysis. Overall, our analysis of the literature and the data suggests that the answer to the question: "Are exchange rates predictable? " is, "It depends " on the choice of predictor, forecast horizon, sample period, model, and forecast evaluation method. Predictability is most apparent when one or more of the following hold: the predictors are Taylor rule or net foreign assets, the model is lin-ear, and a small number of parameters are estimated. The toughest benchmark is the random walk without drift