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Smooth breaks and nonlinear mean reversion in real interest parity: Evidence from East Asian countries

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  • Abdullah Gulcu
  • Dilem Yildirim

Abstract

This study aims to explore the empirical validity of the real interest rate parity (RIP) hypothesis for East Asian countries using Japan as the base country. To this end, we employ the recently proposed unit root tests of Christopoulos and Leon-Ledesma that account for both multiple smooth structural breaks of unknown form and nonlinear mean reversion in the series. Our empirical results uncover overwhelming evidences in favor of the RIP hypothesis for the whole countries in our sample. More specifically, through a Fourier approximation, it is observed that all real interest rate differentials display a mean-reverting behavior around an infrequently smooth-breaking mean, with the breaks being in accordance with the financial reforms and economic crises witnessed by the countries. Moreover, the degree of mean reversion appears to vary nonlinearly with the size of real interest rate appreciations and depreciations.

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  • Abdullah Gulcu & Dilem Yildirim, 2019. "Smooth breaks and nonlinear mean reversion in real interest parity: Evidence from East Asian countries," The Journal of International Trade & Economic Development, Taylor & Francis Journals, vol. 28(6), pages 668-685, August.
    • Handle: RePEc:taf:jitecd:v:28:y:2019:i:6:p:668-685
    DOI: 10.1080/09638199.2019.1582083
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    Cited by:

    1. Zixiong Xie & Shyh-Wei Chen & An-Chi Wu, 2023. "Real interest rate parity in the Pacific Rim countries: new empirical evidence," Empirical Economics, Springer, vol. 64(3), pages 1471-1515, March.

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