IDEAS home Printed from
   My bibliography  Save this article

Exchange Rates and Inflation Rates: Exploring Nonlinear Relationships


  • Bahram Adrangi

    () (Pamplin School of Business Administration, The University of Portland, USA)

  • Mary E. Allender

    () (Pamplin School of Business Administration, The University of Portland, USA)

  • Kambiz Raffiee

    () (College of Business, University of Nevada, Reno, USA)


This paper investigates the Purchasing Power Parity Theory (PPP) in the context of possible nonlinear relationships between prices and exchange rates of three key currencies. The main contribution of this paper is testing for nonlinearities and nonlinear relationships in a framework of information arrival. Three issues motivated the paper. First, research interest in exchange rate fluctuations, PPP, and exchange rate pass through. Second, market volatilities have triggered curiosity in nonlineraities in various economic and financial time series and nonlinear relationships and chaos in financial markets. For instance, the study of chaotic behavior may shed some light on the nature of latent nonlinearities. Third, developments in the econometrics of nonlinearity in the last three decades offer researchers new tools for detecting relationships that are inherently nonlinear and may not be conducive to various methodologies that are seeking to impose linear modeling on nonlinear relationships. Our findings show strong evidence that the exchange series exhibit nonlinear dependencies that may be inconsistent with chaotic structure. We identify GARCH(1,1) process as the model that best explains the nonlinearities in the monthly exchange rates and inflation rates. Therefore, we propose and estimate bivariate GARCH(1,1) models of the variances to ascertain the flow of information between exchange rates and prices. Bivariate GARCH models show that, the volatility spillover and information arrival between exchange rates and price levels occur simultaneously. Thus, we find support for the PPP theory and exchange rate pass through in the economies under consideration. We conclude that two theories, i.e., the exchange rate pass through and PPP may simultaneously hold the key to exchange rate analysis.

Suggested Citation

  • Bahram Adrangi & Mary E. Allender & Kambiz Raffiee, 2011. "Exchange Rates and Inflation Rates: Exploring Nonlinear Relationships," Review of Economics & Finance, Better Advances Press, Canada, vol. 1, pages 1-16, April.
  • Handle: RePEc:bap:journl:110201

    Download full text from publisher

    File URL:
    Download Restriction: no

    References listed on IDEAS

    1. Guglielmo Maria Caporale & Mario Cerrato, 2006. "Panel data tests of PPP: a critical overview," Applied Financial Economics, Taylor & Francis Journals, vol. 16(1-2), pages 73-91.
    2. Chan, Kalok & Chan, K C & Karolyi, G Andrew, 1991. "Intraday Volatility in the Stock Index and Stock Index Futures Markets," Review of Financial Studies, Society for Financial Studies, vol. 4(4), pages 657-684.
    3. Brock, William A. & Sayers, Chera L., 1988. "Is the business cycle characterized by deterministic chaos?," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 71-90, July.
    4. Baum, Christopher F. & Barkoulas, John T. & Caglayan, Mustafa, 2001. "Nonlinear adjustment to purchasing power parity in the post-Bretton Woods era," Journal of International Money and Finance, Elsevier, vol. 20(3), pages 379-399, June.
    5. Blume, Lawrence & Easley, David & O'Hara, Maureen, 1994. " Market Statistics and Technical Analysis: The Role of Volume," Journal of Finance, American Finance Association, vol. 49(1), pages 153-181, March.
    6. Mohsen Bahmani-Oskooee & Gour G. Goswami, 2005. "Black Market Exchange Rates and Purchasing Power Parity in Emerging Economies," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 41(3), pages 37-52, May.
    7. Adrangi, Bahram & Chatrath, Arjun & Dhanda, Kanwalroop Kathy & Raffiee, Kambiz, 2001. "Chaos in oil prices? Evidence from futures markets," Energy Economics, Elsevier, vol. 23(4), pages 405-425, July.
    8. Brock, William & Lakonishok, Josef & LeBaron, Blake, 1992. " Simple Technical Trading Rules and the Stochastic Properties of Stock Returns," Journal of Finance, American Finance Association, vol. 47(5), pages 1731-1764, December.
    Full references (including those not matched with items on IDEAS)


    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.

    Cited by:

    1. Mirdala, Rajmund, 2013. "Real Output and Prices Adjustments under Different Exchange Rate Regimes," MPRA Paper 46879, University Library of Munich, Germany.

    More about this item


    Exchange rate; Inflation rate; Nonlinearity; GARCH model; International finance;

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • F00 - International Economics - - General - - - General
    • F3 - International Economics - - International Finance


    Access and download statistics


    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bap:journl:110201. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Carlson). General contact details of provider: .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.