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Do Real Exchange Rates Follow a Nonlinear Mean Reverting Process in Developing Countries

Author

Listed:
  • Mohsen Bahmani-Oskooee

    () (The Center for Research on International Economics and the Department of Economics, The University of Wisconsin-Milwaukee, Milwaukee, WI 53201, USA)

  • Ali M. Kutan

    () (Department of Economics and Finance, Southern Illinois University, Edwardsville, IL 62026-1102, USA; The Emerging Markets Group, Sir Cass Business School, 106 Bunhill Row, London EC1Y 8TZ; The William Davidson Institute, University of Michigan, 724 East University Avenue, Wyly Hall, First Floor, Ann Arbor, MI 48109-1234, USA)

  • Su Zhou

    () (Department of Economics, University of Texas at San Antonio, San Antonio, TX 78249-0633, USA)

Abstract

In an effort to fight relatively high inflation, many developing countries try to manage their nominal exchange rates through official intervention. In addition, developing countries tend to have high transportation costs, tariffs, and nontariff barriers. These factors are among the sources of generating nonlinearity in real exchange rates and hence some nonlinear adjustment toward purchasing power parity (PPP) in developing countries. In this paper, we employ monthly real effective exchange rate (REER) data of 88 developing countries and test the null of nonstationarity versus an alternative of linear stationarity by the means of a conventional unit root test and compare the results with those obtained from a new test in which the null is the same but the alternative hypothesis is nonlinear stationarity. The latter test supports the PPP theory in more developing countries compared with the former test, suggesting that nonlinear adjustment toward PPP in developing countries is an important phenomenon. Reported country characterizations indicate that reversion in REER occurs more often for high-inflation countries and for countries with high flexibility in their exchange rates.

Suggested Citation

  • Mohsen Bahmani-Oskooee & Ali M. Kutan & Su Zhou, 2008. "Do Real Exchange Rates Follow a Nonlinear Mean Reverting Process in Developing Countries," Southern Economic Journal, Southern Economic Association, vol. 74(4), pages 1049-1062, April.
  • Handle: RePEc:sej:ancoec:v:74:4:y:2008:p:1049-1062
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    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange

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