Exchange Rates and Monetary Fundamentals: Evidence from Turkey

The main purpose of the study is to investigate the predictability of exchange rates by using the long horizon regression approach (or the Error Correction Model) derived from the Vector Error Correction Model for Turkey. The data cover the period over the period of 2001:Q1-2016:Q2 as Turkey has adopted floating exchange rate regime since 2001 crisis. The predictive ability of the long horizon regression was evaluated according to in-sample fit and out-of sample analyses. The in-sample fit results indicate that the fundamentals are useful to explain the long horizon changes in exchange rates under the assumption of country specific money demand elasticities. On the other hand, the out-of sample analysis results present evidence that the Error Correction Model outperforms the Random Walk Model during the forecast period, 2008:Q1-2013:Q2; however, the Random Walk beats the Error Correction Model around 2008 recession period owing to elevated information uncertainty and short termism.