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The real exchange rate and real interest differentials: the role of nonlinearities

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Author Info
Nelson C. Mark (University of Notre Dame and NBER, USA)
Young-Kyu Moh (Tulane University, USA)

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Abstract

Recent empirical work has shown the importance of nonlinear adjustment in the dynamics of real exchange rates and real interest differentials. This work suggests that the tenuous empirical linkage between the real exchange rate and the real interest differential might be strengthened by explicitly accounting for these nonlinearities. We pursue this strategy by pricing the real exchange rate by real interest parity. The resulting first-order stochastic difference equation gives the real exchange rate as the expected present value of future real interest differentials which we compute numerically for three candidate nonlinear processes. Regressions of the log real US dollar prices of the Canadian dollar, deutschemark, yen and pound on the fundamental values implied by these nonlinear models are used to evaluate the linkage. The evidence for linkage is stronger when these present values are computed over shorter horizons than for longer horizons. Copyright © 2005 John Wiley & Sons, Ltd.

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File URL: http://hdl.handle.net/10.1002/ijfe.279
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Publisher Info
Article provided by John Wiley & Sons, Ltd. in its journal International Journal of Finance & Economics.

Volume (Year): 10 (2005)
Issue (Month): 4 ()
Pages: 323-335
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Handle: RePEc:ijf:ijfiec:v:10:y:2005:i:4:p:323-335

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  2. Nakagawa, Hironobu, 2002. "Real exchange rates and real interest differentials: implications of nonlinear adjustment in real exchange rates," Journal of Monetary Economics, Elsevier, vol. 49(3), pages 629-649, April. [Downloadable!] (restricted)
  3. repec:att:wimass:1919997 is not listed on IDEAS
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  5. Alexius, Annika, 2001. "Uncovered Interest Parity Revisited," Review of International Economics, Blackwell Publishing, vol. 9(3), pages 505-17, August. [Downloadable!] (restricted)
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  12. Michael, Panos & Nobay, A Robert & Peel, David A, 1997. "Transactions Costs and Nonlinear Adjustment in Real Exchange Rates: An Empirical Investigation," Journal of Political Economy, University of Chicago Press, vol. 105(4), pages 862-79, August.
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  22. Baillie, Richard T. & Osterberg, William P., 2000. "Deviations from daily uncovered interest rate parity and the role of intervention," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 10(3-4), pages 363-379, December. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Juan Carlos Cuestas & Barry Harrison, 2009. "Further evidence on the Real Interest Rate Parity hypothesis in Central and Eastern European Countries: unit roots and nonlinearities," Working Papers 2009/1, Nottingham Trent University, Nottingham Business School, Economics Division. [Downloadable!]
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