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A new analysis of the determinants of the real dollar-sterling exchange rate: 1871-1994

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  • I Paya
  • D Peel

Abstract

Nonlinear models of deviations from PPP have recently provided an important, theoretically well motivated, contribution to the PPP puzzle. In recent work the equilibrium level has been modelled either as constant or as time varying with very similar statistical fits and very different economic implications. The high persistence of both PPP deviations and the proxy variables for the equilibrium real rate might create a problem of spurious coefficient significance. This paper investigates the possibility of spurious regression within nonlinear models of PPP. Monte Carlo experiments show that standard critical values are not appropriate in such a context. To illustrate we consider the real Dollar-Sterling exchange rate over the period 1871-1994. Due to many exchange rate regime changes over the sample period we employ a Bootstrap methodology that preserves the original structure of the estimated residuals and obtain new critical values of the coefficient estimates. A nonlinear (ESTAR) process with a time varying equilibrium proxied by relative wealth and relative income per capita seems to parsimoniously fit the data. Our results provide further evidence for the nonlinear model with a shifting equilibrium and the implied speed of adjustment is found to be substantially faster than previously reported in the literature.

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Bibliographic Info

Paper provided by Lancaster University Management School, Economics Department in its series Working Papers with number 565953.

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Date of creation: 2005
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Handle: RePEc:lan:wpaper:565953

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Cited by:
  1. Yamin Ahmad & Ming Chien Lo & Olena Mykhaylova, 2011. "Volatility and Persistence of Simulated DSGE Real Exchange Rates," Working Papers 11-01, UW-Whitewater, Department of Economics, revised Nov 2012.
  2. Pavlidis Efthymios G & Paya Ivan & Peel David A, 2010. "Specifying Smooth Transition Regression Models in the Presence of Conditional Heteroskedasticity of Unknown Form," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 14(3), pages 1-40, May.
  3. E Pavlidis & I Paya & D Peel, 2009. "Real Exchange Rates and Time-Varying Trade Costs," Working Papers 600537, Lancaster University Management School, Economics Department.
  4. Yamin Ahmad & William Craighead, 2010. "Temporal Aggregation and Purchasing Power Parity Persistence," Working Papers 10-01, UW-Whitewater, Department of Economics, revised Feb 2011.
  5. I Paya & D Peel, 2005. "Temporal aggregation of an ESTAR process," Working Papers 565938, Lancaster University Management School, Economics Department.
  6. Ivan Paya & David A. Peel, 2004. "Temporal Aggregation Of An Estar Process: Some Implications For Purchasing Power Parity Adjustment," Working Papers. Serie AD 2004-25, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).
  7. I A Venetis & I Paya & D Peel, 2009. "ESTAR model with multiple fixed points. Testing and Estimation," Working Papers 599093, Lancaster University Management School, Economics Department.
  8. JamesR. Lothian & MarkP. Taylor, 2008. "Real Exchange Rates Over the Past Two Centuries: How Important is the Harrod-Balassa-Samuelson Effect?," Economic Journal, Royal Economic Society, vol. 118(532), pages 1742-1763, October.

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