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Real exchange rate behavior and optimum currency area in East Asia: Evidence from Generalized Purchasing Power Parity

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  • Mishra, Ritesh Kumar
  • Sharma, Chandan

Abstract

In the aftermath of the Asian financial crisis, the need for monetary and exchange rate cooperation among the Asian countries has increased considerably. In this context, we attempt to evaluate the potential of an optimum currency area (OCA) for a group of eight East Asian countries. For this purpose, this study tests Purchasing Power Parity (PPP) and Generalized PPP (GPPP) hypothesis, which provides stylized facts of real exchange rate. Specifically, we attempt to investigate the symmetry in macroeconomic disturbances and the co-movements of bilateral real exchange rates of the East Asian countries as one of the standard minimum precondition for forming an OCA. Contrary to many previous studies, we find some supportive evidence for GPPP which, in turn, provides support for the feasibility of an optimum currency area in East Asia. However, the presence of asymmetries in the process, through which countries adjust to shocks in the system, indicates that still higher level of economic integration is required to strengthen the case of a currency union. More importantly, our overall results appear to be invariant to the choice of a base currency and therefore it provides support to the argument that both US dollar and Japanese Yen are important for East Asia while considering the case of a currency union.

Suggested Citation

  • Mishra, Ritesh Kumar & Sharma, Chandan, 2010. "Real exchange rate behavior and optimum currency area in East Asia: Evidence from Generalized Purchasing Power Parity," International Review of Financial Analysis, Elsevier, vol. 19(3), pages 205-213, June.
  • Handle: RePEc:eee:finana:v:19:y:2010:i:3:p:205-213
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    References listed on IDEAS

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    Cited by:

    1. EPHREM HABTEMICHAEL REDDA & Paul-Francious Muzindusti, 2017. "Does SADC constitute an optimum currency area? Evidence from generalised purchasing power parity," Proceedings of Economics and Finance Conferences 4807771, International Institute of Social and Economic Sciences.
    2. de Truchis, Gilles & Keddad, Benjamin, 2013. "Southeast Asian monetary integration: New evidences from fractional cointegration of real exchange rates," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 26(C), pages 394-412.
    3. Shafighi, Najla & Gharleghi, Behrooz, 2016. "Feasibility of a currency union in East Asia using the five-variable structural vector autoregressive model," Economic Analysis and Policy, Elsevier, vol. 52(C), pages 45-54.
    4. Guglielmo Maria Caporale & Luis A. Gil-Alana & Kefei You, 2016. "Exchange Rate Linkages between the ASEAN Currencies, the US Dollar and the Chinese RMB," CESifo Working Paper Series 5995, CESifo Group Munich.
    5. repec:eee:reveco:v:49:y:2017:i:c:p:211-222 is not listed on IDEAS
    6. Chen, Xiaofen, 2012. "The dampening effect of bank foreign liabilities on monetary policy: Revisiting monetary cooperation in East Asia," Journal of International Money and Finance, Elsevier, vol. 31(2), pages 412-427.
    7. Al-Khazali, Osamah M. & Leduc, Guillaume & Pyun, Chong Soo, 2011. "Market efficiency of floating exchange rate systems: Some evidence from Pacific-Asian countries," Global Finance Journal, Elsevier, vol. 22(2), pages 154-168.

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