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Threshold adjustment in deviations from the law of one price

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  • Luciana Juvenal
  • Mark P. Taylor

Abstract

Using self-exciting threshold autoregressive models, we explore the validity of the law of one price (LOOP) for sixteen sectors in nine European countries. We and strong evidence of nonlinear mean reversion in deviations from the LOOP and highlight the importance of modelling the real exchange rate in a nonlinear fashion in an attempt to measure speeds of real exchange rate adjustment. Using the US dollar as a reference currency, the half-lives of sectoral real exchange rates shocks, calculated by Monte Carlo integration, imply much faster adjustment than the consensus half-life estimates of three to five years. The results also imply that transaction costs vary significantly across sectors and countries.

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Bibliographic Info

Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2008-027.

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Date of creation: 2008
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Publication status: Published in Studies in Nonlinear Dynamics and Econometrics, September 2008, 12(3)
Handle: RePEc:fip:fedlwp:2008-027

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Keywords: Prices ; Foreign exchange rates;

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Citations

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Cited by:
  1. Juan Carlos Cuestas & Luís A. Gil-Alana, 2009. "Further evidence on the PPP analysis of the Australian dollar: non-linearities, fractional integration and structural changes," Working Papers 2009/3, Nottingham Trent University, Nottingham Business School, Economics Division.
  2. Wallace, Frederick, 2009. "Purchasing power parity in Mexico: a historical note," MPRA Paper 18081, University Library of Munich, Germany.
  3. Chang, Tsangyao & Tzeng, Han-Wen, 2011. "Long-run purchasing power parity with asymmetric adjustment: Further evidence from nine transition countries," Economic Modelling, Elsevier, vol. 28(3), pages 1383-1391, May.
  4. Rodolphe Blavy & Luciana Juvenal, 2008. "Mexico's integration into NAFTA markets: a view from sectoral real exchange rates," Working Papers 2008-046, Federal Reserve Bank of St. Louis.
  5. Václav Žďárek, 2012. "An Empirical Investigation Of The Purchasing Power Parity Hypothesis In European Transition Countries," Prague Economic Papers, University of Economics, Prague, vol. 2012(3), pages 257-276.
  6. Caglayan, Mustafa & Filiztekin, Alpay, 2012. "The law of one price and the role of market structure," MPRA Paper 36975, University Library of Munich, Germany.
  7. Cristina Terra, Frederico Valladares, 2009. "Real Exchange Rate Misalignments," THEMA Working Papers 2009-03, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
  8. Yang-Cheng Lu & Chang, Tsangyao & Chin-Ping Yu, 2011. "Long-Run Purchasing Power Parity with Asymmetric Adjustment: Evidence from Mainland China and Taiwan," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 0(3), pages 59-70, September.
  9. Ajay Shah & Ila Patnaik & Matthieu Stigler, 2010. "Understanding the ADR premium under market segmentation," Working Papers id:2826, eSocialSciences.
  10. Chang, Tsangyao & Chiu, Chi Chen & Tzeng, Han Wen, 2011. "Revisiting Purchasing Power Parity for Nine Transition Countries Using the Rank Test for Nonlinear Cointegration," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 0(2), pages 19-30, June.
  11. Tsangyao Chang & Chia-hao Lee & Guochen Pan, 2012. "Purchasing Power Parity in African Countries: Further Evidence based on the ADL Test for Threshold Cointegration," Economics Bulletin, AccessEcon, vol. 32(1), pages 220-228.
  12. Chang, Tsangyao & Lee, Chia-Hao, 2011. "Hysteresis in Unemployment for G-7 Countries: Threshold Unit Root Test," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 0(4), pages 5-14, December.
  13. Luciana Juvenal & Rodolphe Blavy, 2008. "Mexico's Integration into NAFTA Markets: A View from Sectoral Real Exchange Rates and Transaction Costs," IMF Working Papers 08/123, International Monetary Fund.
  14. Matthieu Bussière & Michele Ca’ Zorzi & Alexander Chudík & Alistair Dieppe, 2010. "Methodological advances in the assessment of equilibrium exchange rates," Working Paper Series 1151, European Central Bank.

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