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Nonstationarity in real exchange rates using unit root tests with a level shift at unknown time

  • Assaf, Ata
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    The empirical literature that tests for purchasing power parity (PPP) by focusing on the stationarity of real exchange rates has so far provided, at best, mixed results. This paper contributes to this discussion by providing new evidence on the stationarity of bilateral real exchange rates, after allowing for regime changes. We test for a unit root in real exchange rates by allowing for a level shift in the DGP. In doing so, we use the unit root tests proposed by Saikkonen and Lütkepohl [Saikkonen, P. and Lütkepohl, H., 2002, Testing for a unit root in a time series with a level shift at unknown time, Econometric Theory 18, 313-348] and Lanne et al. [Lanne, M., Lütkepohl, H., and Saikkonen, P., 2002, Comparison of unit root tests for time series with level shifts, Journal of Time Series Analysis 23, 667-685], which are based on estimating the deterministic term first by a GLS procedure under the unit root null hypothesis and subtracting it from the original series. We subject the series to three level shifts, namely: a shift dummy, an exponential shift and a rational shift. Our results confirm the nonstationarity of real exchange rate series in the presence of structural breaks during the post-Bretton Woods era. Thus, the real exchange rate behavior may not be so different after all but simply perceived to be so because of the use of previously restrictive unit root tests.

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    Article provided by Elsevier in its journal International Review of Economics & Finance.

    Volume (Year): 17 (2008)
    Issue (Month): 2 ()
    Pages: 269-278

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    Handle: RePEc:eee:reveco:v:17:y:2008:i:2:p:269-278
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    1. Saikkonen, Pentti & L tkepohl, Helmut, 2002. "Testing For A Unit Root In A Time Series With A Level Shift At Unknown Time," Econometric Theory, Cambridge University Press, vol. 18(02), pages 313-348, April.
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    8. Markku Lanne & Helmut Lutkepohl & Pentti Saikkonen, 2003. "Test Procedures for Unit Roots in Time Series with Level Shifts at Unknown Time," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 65(1), pages 91-115, February.
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    15. Michael Dueker & Apostolos Serletis, 2000. "Do real exchange rates have autoregressive unit roots? a test under the alternative of long memory and breaks," Working Papers 2000-016, Federal Reserve Bank of St. Louis.
    16. Gil-Alana, Luis A., 2000. "Mean reversion in the real exchange rates," Economics Letters, Elsevier, vol. 69(3), pages 285-288, December.
    17. Cheung, Yin-Wong & Lai, Kon S., 2001. "Long memory and nonlinear mean reversion in Japanese yen-based real exchange rates," Journal of International Money and Finance, Elsevier, vol. 20(1), pages 115-132, February.
    18. Henry, Olan T. & Olekalns, Nilss, 2002. "Does the Australian dollar real exchange rate display mean reversion," Journal of International Money and Finance, Elsevier, vol. 21(5), pages 651-666, October.
    19. Cheung, Yin-Wong & Lai, Kon S., 1998. "Parity reversion in real exchange rates during the post-Bretton Woods period," Journal of International Money and Finance, Elsevier, vol. 17(4), pages 597-614, August.
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