This paper investigates the empirical disconnect between exchange rates and economic fundamentals that is at the heart of several exchange rate puzzles. In contrast to a literature characterized by notoriously poor in-sample Þts and out-ofsample forecast failures, we Þnd that for three major OECD primary commodity producers, nominal exchange rates exhibit a robust response to movements in the world prices of their corresponding commodity exports. Moreover, incorporating commodity export prices into standard exchange rate models can generate a marked improvement in their in-sample performance. In terms of out-of-sample forecast, several commodity-price-augmented speciÞcations offer clear evidence of exchange rate predictability, after accounting for small-sample bias and size distortion in asymptotic tests. However, no single speciÞcation is found to provide a consistent forecast improvement over a random walk at all horizons and across all currency pairs. The empirical approach and evidence shown in this paper can be applied to a much wider set of countries and have particular relevance for monetary policy making and insation control in small commodity economies.
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