Forecasting Exchange Rate from Combination Taylor Rule Fundamental

This study examines the forecasting performance of the Taylor rule on the exchange rate when there is uncertainty in the structural breaks in a small open economy. Using the combination window method, which considers the uncertainty of the size of the estimation window, we find that the out-of-sample forecasting performance of our approach is better than that of other benchmark models in the U.S. dollar-Korean won exchange rate. This finding indicates that the expected exchange rate is influenced by the capital mobility between small and large open economies, which is driven by the dynamic interactions of monetary policies between the two countries, and that the forecasting outcome is sensitive to the estimation window size and to whether or not the window reflects changes in the policy regime.