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Nonlinear Adjustment in Real Exchange Rates and Long Run Purchasing Power Parity--Further Evidence

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  • Darbha, Gangadhar

    (U of Pennsylvania)

  • Patel, Urjit R.

    (Infrastructure Development Finance Corporation)

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    Abstract

    The paper investigates, using a threshold autoregression model, the nature of nonlinear adjustments in real exchange rates (RERs) arising from the presence of transaction costs and uncertainty, and their implications for the testing of unit roots. Using monthly data for the U.S. vis-a-vis 19 trading partners we find that most RERs are better characterized by a mean reverting nonlinear stochastic process, with large changes converging faster than small changes, implying that there is convergence towards PPP equilibrium at least in the long-run, albeit in a non-linear manner. It is found that, across countries and commodity groups, there is an association between geographical and trade related proximity and the estimated speeds of adjustment. In addition, policy agreements that mitigate exchange rate uncertainty such as the Louvre Accord could have contributed to greater international commodity arbitrage.

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    Bibliographic Info

    Paper provided by University of Pennsylvania, Wharton School, Weiss Center in its series Working Papers with number 04-1.

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    Date of creation: Mar 2004
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    Handle: RePEc:ecl:upafin:04-1

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    21. Delgado, Francisco A., 1991. "Hysteresis, menu costs, and pricing with random exchange rates," Journal of Monetary Economics, Elsevier, Elsevier, vol. 28(3), pages 461-484, December.
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