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What do we know about real exchange rate nonlinearities?

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Author Info

  • Robinson Kruse

    ()

  • Michael Frömmel

    ()

  • Lukas Menkhoff

    ()

  • Philipp Sibbertsen

    ()

Abstract

Nonlinear modeling of adjustments to purchasing power parity has recently gained much attention. However, a huge body of the empirical literature applies ESTAR models and neglects the existence of other competing nonlinear models. Among these, the Markov Switching AR model has a strong substantiation in international finance. Our contribution to the literature is fivefold: First, ESTAR and MSAR models from a unit root perspective are compared. To this end, a new unit root test against MSAR is proposed as the second contribution. Thirdly, the case of misspecified alternatives in a Monte Carlo setup with real world parameter constellations is studied. The ESTAR unit root test is not indicative, while the MSAR unit test is robust. Fourthly, the case of correctly specified alternatives is considered and low power of the ESTAR but not for the MSAR unit root test is observed. Fifthly, an empirical application to real exchange rates suggests that they may indeed be explained by Markov Switching dynamics rather than ESTAR. Copyright Springer-Verlag 2012

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Bibliographic Info

Article provided by Springer in its journal Empirical Economics.

Volume (Year): 43 (2012)
Issue (Month): 2 (October)
Pages: 457-474

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Handle: RePEc:spr:empeco:v:43:y:2012:i:2:p:457-474

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Keywords: Real exchange rates; Unit root test; ESTAR; Markov Switching; PPP; C12; C22; F31;

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References

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Citations

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Cited by:
  1. Aloy, Marcel & Boutahar, Mohamed & Gente, Karine & Péguin-Feissolle, Anne, 2011. "Purchasing power parity and the long memory properties of real exchange rates: Does one size fit all?," Economic Modelling, Elsevier, vol. 28(3), pages 1279-1290, May.
  2. Kaufmann, Hendrik & Kruse, Robinson & Sibbertsen, Philipp, 2012. "On tests for linearity against STAR models with deterministic trends," Hannover Economic Papers (HEP) dp-492, Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät.
  3. Beckmann, Joscha, 2013. "Nonlinear adjustment, purchasing power parity and the role of nominal exchange rates and prices," The North American Journal of Economics and Finance, Elsevier, vol. 24(C), pages 176-190.
  4. Niels Haldrup & Robinson Kruse & Timo Teräsvirta & Rasmus T. Varneskov, 2012. "Unit roots, nonlinearities and structural breaks," CREATES Research Papers 2012-14, School of Economics and Management, University of Aarhus.

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