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What do we know about real exchange rate non-linearities?

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Author Info

  • Robinson Kruse

    ()
    (Aarhus University and CREATES)

  • Michael Frömmel

    (Ghent University)

  • Lukas Menkhoff

    (Leibniz University Hannover)

  • Philipp Sibbertsen

    (Leibniz University Hannover)

Abstract

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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Bibliographic Info

Paper provided by School of Economics and Management, University of Aarhus in its series CREATES Research Papers with number 2009-50.

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Length: 25
Date of creation: 28 May 2009
Date of revision:
Handle: RePEc:aah:create:2009-50

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Web page: http://www.econ.au.dk/afn/

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Keywords: real exchange rates; unit root test; ESTAR; Markov Switching; PPP;

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References

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Citations

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Cited by:
  1. 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.
  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. Marcel Aloy & Mohamed Boutahar & Karine Gente & Anne Peguin-Feissolle, 2011. "Purchasing power parity and the long memory properties of real exchange rates: does one size fit all?," Working Papers halshs-00559170, HAL.
  4. 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.

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