Why is it difficult to beat the random walk forecast of exchange rates?

Recent empirical evidence suggests that the time series behavior of the real exchange rateis well approximated by a nonlinear, exponential smooth transition autoregressive (ESTAR) model. This nonlinearity helps resolve a number of puzzles concerning the persistence andvolatility of real exchange rates. In this paper, we explore whether it may also help resolve the well-known difficulties of exchange rate forecasting. We develop a bootstrap test of the random walk hypothesis of the nominal exchange rate, given ESTAR real exchange rate dynamics. We find strong evidence of predictability at horizons of 2 to 3 years, but not at shorter horizons.