Robinson Kruse () (Aarhus University and CREATES) Michael Frömmel (Ghent University) Lukas Menkhoff (Leibniz University Hannover) Philipp Sibbertsen (Leibniz University Hannover)
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This research points to the serious problem of potentially misspecified alternative hypotheses when testing for unit roots in real exchange rates. We apply a popular unit root test against nonlinear ESTAR and develop a Markov Switching unit root test. The empirical power of these tests against correctly and misspecified non-linear alternatives is analyzed by means of a Monte Carlo study. The chosen parametrization is obtained by real-life exchange rates. The test against ESTAR has low power against all alternatives whereas the proposed unit root test against a Markov Switching autoregressive model performs clearly better. An empirical application of these tests suggests that real exchange rates may indeed be explained by Markov-Switching dynamics.
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Paper provided by School of Economics and Management, University of Aarhus in its series CREATES Research Papers with number
2009-50.