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Modelling The Us/Uk Real Exchange Rate–Real Interest Rate Differential Relation: A Multivariate Regime Switching Approach

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  • ANGELOS KANAS

Abstract

This paper investigates the empirical link between the US/UK real exchange rate and real interest differential for the period 1959–2002, using a bivariate Markov switching vector autoregression model. We find strong evidence of volatility regime switching in the US/UK real exchange rate–real interest differential relation. There is also evidence of a regime‐dependent dynamic link. These findings indicate that allowing for multivariate regime switching can reconcile theoretical models of exchange rates which predict a strong link between real exchange rates and the real interest differential, and previous empirical evidence which failed to uncover such a link.

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  • Angelos Kanas, 2005. "Modelling The Us/Uk Real Exchange Rate–Real Interest Rate Differential Relation: A Multivariate Regime Switching Approach," Manchester School, University of Manchester, vol. 73(2), pages 123-140, March.
    • Handle: RePEc:bla:manchs:v:73:y:2005:i:2:p:123-140
    DOI: 10.1111/j.1467-9957.2005.00439.x
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    Cited by:

    1. Nikolaos Giannellis & Athanasios Papadopoulos, 2007. "Estimating the Equilibrium Effective Exchange Rate for Potential EMU Members," Open Economies Review, Springer, vol. 18(3), pages 307-326, July.
    2. Kanas, Angelos, 2005. "Regime linkages in the US/UK real exchange rate-real interest differential relation," Journal of International Money and Finance, Elsevier, vol. 24(2), pages 257-274, March.

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