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Nonlinear Modelling of Purchasing Power Parity in Indonesia

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Author Info
Param Silvapulle
Titi Kanti Lestari
Jae Kim

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Abstract

This paper models the dynamics of the adjustment process of Indonesian purchasing power parity (PPP) relative to US, Japan and Singapore by employing a nonlinear framework, which is recently shown to be appropriate in the presence of transaction costs associated with international trade. Using monthly observations from January 1979 to June 2003 (post-Bretton Woods period), covering the managed- and free-floating regimes in Indonesia, the real exchange rates were tested for their mean-reverting properties. A large number of studies found the real exchange series to be mean-averting and persistent, creating PPP puzzles. Using the linear framework many attempted to resolve these puzzles unsuccesfully. Motivated by the success of recent studies on PPP, applying a non-linear ESTAR to model the adjustment process, we tested for mean-reverting properties of all three real exchange rates for small and large deviations from the long-run equilibrium. We find that the small deviations are non-stationary, persistent and they can be explosive, while the large deviations are stationary with the adjustment process being very fast, making the overall adjustment process mean-reverting

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Paper provided by Econometric Society in its series Econometric Society 2004 Australasian Meetings with number 316.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:ausm04:316

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Related research
Keywords: Purchasing Power Parity; ESTAR model; Mean-reversion;

Find related papers by JEL classification:
C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions
F31 - International Economics - - International Finance - - - Foreign Exchange
F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements

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    Other versions:
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