This paper uses a SETAR model to determine threshold(s) in the RMB/US$ exchange rate from 1981 to 2016 using monthly data. Also, it compares the forecast performance of the univariate nonlinear model to a univariate linear model. We further analyze the forecast performance of the SETAR model to a multivariate linear model, e.g., a Reduced-form VAR. In addition, the research assesses the claim by Boero and Marrocu (2002) that the root mean square error masks the superiority of the nonlinear models.

We found five significant thresholds in the RMB/US$ exchange rate, and this result reflects five major episodes of policy reforms or structural changes in the renminbi exchange rates from the period 1981 to 2016. We also found that the univariate nonlinear model out performs both the univariate and multivariate linear models in predicting the exchange rate movements. This finding is consistent with the results in Kyei and Gyamfi (2016), Boero and Marrocu (2002), Krager and Kugler (1993), Peel and Speight (1994) and Chappell et al. (1996). Furthermore, we did not find any evidence of the root mean square error masking the superiority of the nonlinear model.