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Mean Reversion in G-10 Nominal Exchange Rates

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  • Sweeney, Richard J.

Abstract

According to conventional wisdom, industrial country floating exchange rates contain unit roots. SUR tests on panels of monthly Group of Ten (G-10) log nominal rates reject the null of unit roots for various samples over the current float with significance levels from 0.5% to 15%. On average, in out-of-sample forecasts mean reversion models beat random walks significantly in some forecast periods. For monthly data, the range of expected USD-DEM appreciation rates exceeds 15% per year in the mean reversion model. Mean reversion places strong restrictions on international models: over the sample period, the G-10 had to run monetary policies consistent with stable long-run nominal rates.

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  • Sweeney, Richard J., 2006. "Mean Reversion in G-10 Nominal Exchange Rates," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 41(3), pages 685-708, September.
    • Handle: RePEc:cup:jfinqa:v:41:y:2006:i:03:p:685-708_00
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    2. Rongju Zhang & Mark Aarons & Gregoire Loeper, 2019. "Optimal FX Hedge Tenor with Liquidity Risk," Papers 1903.06346, arXiv.org.
    3. Chiu, Mei Choi & Wong, Hoi Ying, 2011. "Mean-variance portfolio selection of cointegrated assets," Journal of Economic Dynamics and Control, Elsevier, vol. 35(8), pages 1369-1385, August.
    4. Tsangyao Chang & Ding Li & Yang-Cheng Lu & Chia-Hao Lee, 2011. "Purchasing power parity for East-Asia countries: further evidence based on panel stationary test with multiple structural breaks," Applied Economics, Taylor & Francis Journals, vol. 43(24), pages 3289-3298.
    5. Chiu, Hsin-Yu & Chen, Ting-Fu, 2020. "Impact of volatility jumps in a mean-reverting model: Derivative pricing and empirical evidence," The North American Journal of Economics and Finance, Elsevier, vol. 52(C).
    6. Tobias F. Rotheli, 2016. "Appreciation Pressures and Real Depreciation: The Experience with the Swiss Franc-Euro Exchange Rate Floor," International Business Research, Canadian Center of Science and Education, vol. 9(8), pages 84-90, August.
    7. Zhong, Yinhui & Bao, Qunfang & Li, Shenghong, 2015. "FX options pricing in logarithmic mean-reversion jump-diffusion model with stochastic volatility," Applied Mathematics and Computation, Elsevier, vol. 251(C), pages 1-13.
    8. Guo, Hui & Savickas, Robert, 2008. "Forecasting foreign exchange rates using idiosyncratic volatility," Journal of Banking & Finance, Elsevier, vol. 32(7), pages 1322-1332, July.
    9. Chiu, Mei Choi & Wong, Hoi Ying, 2013. "Optimal investment for an insurer with cointegrated assets: CRRA utility," Insurance: Mathematics and Economics, Elsevier, vol. 52(1), pages 52-64.
    10. Chiu, Mei Choi & Wong, Hoi Ying, 2012. "Mean–variance asset–liability management: Cointegrated assets and insurance liability," European Journal of Operational Research, Elsevier, vol. 223(3), pages 785-793.
    11. P. S. Sephton, 2010. "Unit roots and purchasing power parity: another kick at the can," Applied Economics, Taylor & Francis Journals, vol. 42(27), pages 3439-3453.
    12. Adam Zaremba & Jacob Koby Shemer, 2018. "Price-Based Investment Strategies," Springer Books, Springer, number 978-3-319-91530-2, December.
    13. Wong, Hoi Ying & Lo, Yu Wai, 2009. "Option pricing with mean reversion and stochastic volatility," European Journal of Operational Research, Elsevier, vol. 197(1), pages 179-187, August.
    14. Buckley, Winston S. & Long, Hongwei, 2015. "A discontinuous mispricing model under asymmetric information," European Journal of Operational Research, Elsevier, vol. 243(3), pages 944-955.
    15. Fan, Kun & Shen, Yang & Siu, Tak Kuen & Wang, Rongming, 2014. "Pricing foreign equity options with regime-switching," Economic Modelling, Elsevier, vol. 37(C), pages 296-305.
    16. Azad, A.S.M. Sohel, 2009. "Random walk and efficiency tests in the Asia-Pacific foreign exchange markets: Evidence from the post-Asian currency crisis data," Research in International Business and Finance, Elsevier, vol. 23(3), pages 322-338, September.
    17. Giorgio Ferrari & Tiziano Vargiolu, 2020. "On the singular control of exchange rates," Annals of Operations Research, Springer, vol. 292(2), pages 795-832, September.

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