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Nonstationarity in real exchange rates using unit root tests with a level shift at unknown time

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  • Assaf, Ata
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    Abstract

    The empirical literature that tests for purchasing power parity (PPP) by focusing on the stationarity of real exchange rates has so far provided, at best, mixed results. This paper contributes to this discussion by providing new evidence on the stationarity of bilateral real exchange rates, after allowing for regime changes. We test for a unit root in real exchange rates by allowing for a level shift in the DGP. In doing so, we use the unit root tests proposed by Saikkonen and Lütkepohl [Saikkonen, P. and Lütkepohl, H., 2002, Testing for a unit root in a time series with a level shift at unknown time, Econometric Theory 18, 313-348] and Lanne et al. [Lanne, M., Lütkepohl, H., and Saikkonen, P., 2002, Comparison of unit root tests for time series with level shifts, Journal of Time Series Analysis 23, 667-685], which are based on estimating the deterministic term first by a GLS procedure under the unit root null hypothesis and subtracting it from the original series. We subject the series to three level shifts, namely: a shift dummy, an exponential shift and a rational shift. Our results confirm the nonstationarity of real exchange rate series in the presence of structural breaks during the post-Bretton Woods era. Thus, the real exchange rate behavior may not be so different after all but simply perceived to be so because of the use of previously restrictive unit root tests.

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    Bibliographic Info

    Article provided by Elsevier in its journal International Review of Economics & Finance.

    Volume (Year): 17 (2008)
    Issue (Month): 2 ()
    Pages: 269-278

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    Handle: RePEc:eee:reveco:v:17:y:2008:i:2:p:269-278

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    Web page: http://www.elsevier.com/locate/inca/620165

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    1. Lanne, Markku & Lütkepohl, Helmut & Saikkonen, Pentti, 2001. "Test procedures for unit roots in time series with level shifts at unknown time," SFB 373 Discussion Papers 2001,39, Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes.
    2. James G. MacKinnon, 1990. "Critical Values for Cointegration Tests," Working Papers 1227, Queen's University, Department of Economics.
    3. Gil-Alana, Luis A., 2000. "Mean reversion in the real exchange rates," Economics Letters, Elsevier, vol. 69(3), pages 285-288, December.
    4. Helmut Luetkepohl & Pentti Saikkonen, 2000. "Testing for a Unit Root in a Time Series with a Level Shift at Unknown Time," Econometric Society World Congress 2000 Contributed Papers 0342, Econometric Society.
    5. Olekalns, Nilss & Wilkins, Nigel, 1998. "Re-examining the Evidence for Long-Run Purchasing Power Parity," The Economic Record, The Economic Society of Australia, vol. 74(224), pages 54-61, March.
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    7. Cheung, Yin-Wong & Lai, Kon S., 2001. "Long memory and nonlinear mean reversion in Japanese yen-based real exchange rates," Journal of International Money and Finance, Elsevier, vol. 20(1), pages 115-132, February.
    8. Henry, Olan T. & Olekalns, Nilss, 2002. "Does the Australian dollar real exchange rate display mean reversion," Journal of International Money and Finance, Elsevier, vol. 21(5), pages 651-666, October.
    9. Michael Dueker & Apostolos Serletis, 2000. "Do real exchange rates have autoregressive unit roots? a test under the alternative of long memory and breaks," Working Papers 2000-016, Federal Reserve Bank of St. Louis.
    10. Cheung, Yin-Wong & Lai, Kon S., 1998. "Parity reversion in real exchange rates during the post-Bretton Woods period," Journal of International Money and Finance, Elsevier, vol. 17(4), pages 597-614, August.
    11. Baum, Christopher F. & Barkoulas, John T. & Caglayan, Mustafa, 2001. "Nonlinear adjustment to purchasing power parity in the post-Bretton Woods era," Journal of International Money and Finance, Elsevier, vol. 20(3), pages 379-399, June.
    12. Phylaktis, Kate & Kassimatis, Yiannis, 1994. "Does the real exchange rate follow a random walk? The Pacific Basin perspective," Journal of International Money and Finance, Elsevier, vol. 13(4), pages 476-495, August.
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    14. Perron, Pierre, 1990. "Testing for a Unit Root in a Time Series with a Changing Mean," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(2), pages 153-62, April.
    15. Kenneth A. Froot & Kenneth Rogoff, 1994. "Perspectives on PPP and Long-Run Real Exchange Rates," NBER Working Papers 4952, National Bureau of Economic Research, Inc.
    16. Apostolos Serletis & Periklis Gogas, 2000. "Purchasing power parity, nonlinearity and chaos," Applied Financial Economics, Taylor & Francis Journals, vol. 10(6), pages 615-622.
    17. Serletis, Apostolos & Zimonopoulos, Grigorios, 1997. "Breaking Trend Functions in Real Exchange Rates: Evidence from Seventeen OECD Countries," Journal of Macroeconomics, Elsevier, vol. 19(4), pages 781-802, October.
    18. Peel, David & Sarno, Lucio & Taylor, Mark P, 2001. "Nonlinear Mean-Reversion in Real Exchange Rates: Towards a Solution to the Purchasing Power Parity Puzzles," CEPR Discussion Papers 2658, C.E.P.R. Discussion Papers.
    19. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
    20. Luis Gil-Alana, 2002. "Real exchange rates: evidence from black markets using fractionally integrated semiparametric techniques," Applied Economics Letters, Taylor & Francis Journals, vol. 9(12), pages 787-790.
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    Cited by:
    1. Antonio E. Noriega & Daniel Ventosa-Santaulària, 2010. "Spurious Long-Horizon Regression in Econometrics," Working Papers 2010-06, Banco de México.
    2. Cristina Terra, Frederico Valladares, 2009. "Real Exchange Rate Misalignments," THEMA Working Papers 2009-03, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.

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