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Exchange Rates and Markov Switching Dynamics

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Author Info
Yin-wong Cheung (University of California, Santa Cruz, Hong Kong Institute for Monetary Research)
Ulf G. Erlandsson (Lund University)

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Abstract

This article presents a systematic and extensive empirical study on the presence of Markov switching dynamics in three dollar-based exchange rates. A Monte Carlo approach is adopted to circumvent the statistical inference problem inherent in the test of regime-switching behavior. Two data frequencies, two sample periods, and various specifications are considered. Quarterly data yield inconclusive evidence - the test rejects neither random walk nor Markov switching. Monthly data, on the other hand, offer unambiguous evidence of the presence of Markov switching dynamics. The results suggest that data frequency, in addition to sample size, is crucial for determining the number of regimes.

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Publisher Info
Paper provided by Hong Kong Institute for Monetary Research in its series Working Papers with number 052005.

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Length: 19 pages
Date of creation: May 2005
Date of revision:
Handle: RePEc:hkm:wpaper:052005

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Related research
Keywords: Exchange Rate Dynamics; Regime Switching; Monte Carlo Test; Sampling Frequency;

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Engel, Charles & Hamilton, James D, 1990. "Long Swings in the Dollar: Are They in the Data and Do Markets Know It?," American Economic Review, American Economic Association, vol. 80(4), pages 689-713, September. [Downloadable!] (restricted)
  2. Tobias Rydén & Timo Teräsvirta & Stefan Åsbrink, 1998. "Stylized facts of daily return series and the hidden Markov model," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 13(3), pages 217-244. [Downloadable!]
    Other versions:
  3. Meese, Richard A & Rose, Andrew K, 1991. "An Empirical Assessment of Non-linearities in Models of Exchange Rate Determination," Review of Economic Studies, Blackwell Publishing, vol. 58(3), pages 603-19, May. [Downloadable!] (restricted)
    Other versions:
  4. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February. [Downloadable!] (restricted)
  5. Yin-Wong Cheung & Menzie David Chinn & Antonio Garcia Pascual, 2004. "Empirical Exchange Rate Models of the Nineties: Are Any Fit to Survive?," IMF Working Papers 04/73, International Monetary Fund. [Downloadable!]
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  6. Hansen, Bruce E, 1992. "The Likelihood Ratio Test under Nonstandard Conditions: Testing the Markov Switching Model of GNP," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 7(S), pages S61-82, Suppl. De. [Downloadable!] (restricted)
  7. Bollen, Nicolas P. B. & Gray, Stephen F. & Whaley, Robert E., 2000. "Regime switching in foreign exchange rates: Evidence from currency option prices," Journal of Econometrics, Elsevier, vol. 94(1-2), pages 239-276. [Downloadable!] (restricted)
  8. Lamoureux, Christopher G & Lastrapes, William D, 1990. "Persistence in Variance, Structural Change, and the GARCH Model," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(2), pages 225-34, April.
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  10. Chinn, Menzie D. & Meese, Richard A., 1995. "Banking on currency forecasts: How predictable is change in money?," Journal of International Economics, Elsevier, vol. 38(1-2), pages 161-178, February. [Downloadable!] (restricted)
  11. Cai, Jun, 1994. "A Markov Model of Switching-Regime ARCH," Journal of Business & Economic Statistics, American Statistical Association, vol. 12(3), pages 309-16, July.
  12. Engel, Charles, 1994. "Can the Markov switching model forecast exchange rates?," Journal of International Economics, Elsevier, vol. 36(1-2), pages 151-165, February. [Downloadable!] (restricted)
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  13. Garcia, Rene, 1998. "Asymptotic Null Distribution of the Likelihood Ratio Test in Markov Switching Models," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(3), pages 763-88, August.
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  14. Fangxiong Gong & Roberto S. Mariano, 1997. "Testing under non-standard conditions in frequency domain: with applications to Markov regime-switching models of exchange rates and federal funds rate," Staff Reports 23, Federal Reserve Bank of New York. [Downloadable!]
  15. Patrick J. Coe, 2002. "Power issues when testing the Markov switching model with the sup likelihood ratio test using U.S. output," Empirical Economics, Springer, vol. 27(2), pages 395-401. [Downloadable!] (restricted)
  16. Dewachter, Hans, 2001. "Can Markov switching models replicate chartist profits in the foreign exchange market?," Journal of International Money and Finance, Elsevier, vol. 20(1), pages 25-41, February. [Downloadable!] (restricted)
  17. Cheung, Yin-Wong, 1993. "Long Memory in Foreign-Exchange Rates," Journal of Business & Economic Statistics, American Statistical Association, vol. 11(1), pages 93-101, January.
  18. Paul De Grauwe & Isabel Vansteenkiste, 2001. "Exchange Rates and fundamentals a Non-Linear Relationship?," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Huisman, R. & Mahieu, R.J., 2007. "Revisiting Uncovered Interest Rate Parity: Switching Between UIP and the Random Walk," Research Paper ERS-2007-001-F&A Revision, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus Uni. [Downloadable!]
  2. Yilmazkuday, Hakan & Akay, Koray, 2008. "An analysis of regime shifts in the Turkish economy," Economic Modelling, Elsevier, vol. 25(5), pages 885-898, September. [Downloadable!] (restricted)
  3. Erlandsson, Ulf, 2005. "Transition Variables in the Markov-switching Model: Some Small Sample Properties," Working Papers 2005:25, Lund University, Department of Economics. [Downloadable!]
  4. Erlandsson, Ulf, 2004. "Reconnecting the Markov Switching Model with Economic Fundamentals," Working Papers 2004:4, Lund University, Department of Economics, revised 18 Mar 2004. [Downloadable!]
  5. Chew Lian Chua & Sandy Suardi, 2005. "Is There a Unit Root in East-Asian Short-Term Interest Rates?," Melbourne Institute Working Paper Series wp2005n14, Melbourne Institute of Applied Economic and Social Research, The University of Melbourne. [Downloadable!]
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