Detecting mean reversion within reflecting barriers: application to the European Exchange Rate Mechanism
This paper derives a statistical test, based on the first-order autocorrelation, to ascertain whether a stochastic process evolving within reflecting barriers is mean reverting. Under these conditions the standard unit root analysis does not apply. Since the presence of reflecting barriers per se will induce mean reverting behaviour, the detection of mean reversion inside the two boundaries requires that the effect of reflection be properly accounted for. This statistical procedure may be useful in a number of economic applications which involve an assesment on the dynamics of bounded variables: e.g. the estimation of the mean reversion of ratios in capital structure theory, market share analysis, or the empirical testing of target zones models for exchange rates. We exemplify the inappropriateness of standard unit root analysis in these situations using European Monetary System exchange rate data. Our methodology is helpful in deciding whether the mean reverting behaviour of these exchange rates is due solely to local behaviour at the barriers, or whether a more complex interpretation is warranted. We apply our test to the target zone model introduced by Krugman where the intervention bands are credible. We study bilateral exchange rates of currencies party to the European Monetary System during a period of sustained stability consistent with the credible band assumption. Our results are consistent with those obtained employing significantly more complex maximum likelihood procedures.
If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
Volume (Year): 5 (1998)
Issue (Month): 1 ()
|Contact details of provider:|| Web page: http://www.tandfonline.com/RAMF20|
|Order Information:||Web: http://www.tandfonline.com/pricing/journal/RAMF20|
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Hali J. Edison & Eric Fisher, 1989.
"A long-run view of the european monetary system,"
International Finance Discussion Papers
339, Board of Governors of the Federal Reserve System (U.S.).
- Phillips, P C B, 1987.
"Time Series Regression with a Unit Root,"
Econometric Society, vol. 55(2), pages 277-301, March.
- Tom Doan, . "PPUNIT: RATS procedure to perform Phillips-Perron Unit Root test," Statistical Software Components RTS00160, Boston College Department of Economics.
- Peter C.B. Phillips, 1985. "Time Series Regression with a Unit Root," Cowles Foundation Discussion Papers 740R, Cowles Foundation for Research in Economics, Yale University, revised Feb 1986.
- Schwert, G William, 1989.
"Tests for Unit Roots: A Monte Carlo Investigation,"
Journal of Business & Economic Statistics,
American Statistical Association, vol. 7(2), pages 147-59, April.
- Lo, Andrew W., 1988.
"Maximum Likelihood Estimation of Generalized Itô Processes with Discretely Sampled Data,"
Cambridge University Press, vol. 4(02), pages 231-247, August.
- Andrew W. Lo, 1986. "Maximum Likelihood Estimation of Generalized Ito Processes with Discretely Sampled Data," NBER Technical Working Papers 0059, National Bureau of Economic Research, Inc.
- Andrew W. Lo, . "Maximum Likelihood Estimation of Generalized Ito Processes with Discretely Sampled Data," Rodney L. White Center for Financial Research Working Papers 15-86, Wharton School Rodney L. White Center for Financial Research.
- Meese, Richard A & Singleton, Kenneth J, 1982. " On Unit Roots and the Empirical Modeling of Exchange Rates," Journal of Finance, American Finance Association, vol. 37(4), pages 1029-35, September.
- Donald J. Mathieson & Robert P. Flood & Andrew K. Rose, 1991.
"An Empirical Exploration of Exchange Rate Target-Zones,"
IMF Working Papers
91/15, International Monetary Fund.
- Flood, Robert P. & Rose, Andrew K. & Mathieson, Donald J., 1991. "An empirical exploration of exchange-rate target-zones," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 35(1), pages 7-65, January.
- Robert P. Flood & Andrew K. Rose & Donald J. Mathieson, 1990. "An Empirical Exploration of Exchange Rate Target-Zones," NBER Working Papers 3543, National Bureau of Economic Research, Inc.
- Perron, P, 1988.
"The Great Crash, The Oil Price Shock And The Unit Root Hypothesis,"
338, Princeton, Department of Economics - Econometric Research Program.
- Perron, Pierre, 1989. "The Great Crash, the Oil Price Shock, and the Unit Root Hypothesis," Econometrica, Econometric Society, vol. 57(6), pages 1361-1401, November.
- Peter C.B. Phillips, 1986.
"Regression Theory for Near-Integrated Time Series,"
Cowles Foundation Discussion Papers
781R, Cowles Foundation for Research in Economics, Yale University, revised Jan 1987.
- Paul R. Krugman, 1991. "Target Zones and Exchange Rate Dynamics," The Quarterly Journal of Economics, Oxford University Press, vol. 106(3), pages 669-682.
- Evans, G B A & Savin, N E, 1981. "Testing for Unit Roots: 1," Econometrica, Econometric Society, vol. 49(3), pages 753-79, May.
- Paul Krugman & Marcus Miller, 1992. "Exchange Rate Targets and Currency Bands," NBER Books, National Bureau of Economic Research, Inc, number krug92-1, March.
- Ball, Clifford A. & Roma, Antonio, 1993. "A jump diffusion model for the European monetary system," Journal of International Money and Finance, Elsevier, vol. 12(5), pages 475-492, October.
- Ball, Clifford A. & Roma, Antonio, 1994. "Target zone modelling and estimation for European Monetary System exchange rates," Journal of Empirical Finance, Elsevier, vol. 1(3-4), pages 385-420, July.
- Dickey, David A & Fuller, Wayne A, 1981. "Likelihood Ratio Statistics for Autoregressive Time Series with a Unit Root," Econometrica, Econometric Society, vol. 49(4), pages 1057-72, June.
- Evans, G B A & Savin, N E, 1984. "Testing for Unit Roots: 2," Econometrica, Econometric Society, vol. 52(5), pages 1241-69, September.
- Lindbecg, H. Soderlind, P., 1992. "Target Zone Models and the Intervention Policy; The Swedish Case," Papers 496, Stockholm - International Economic Studies.
When requesting a correction, please mention this item's handle: RePEc:taf:apmtfi:v:5:y:1998:i:1:p:1-15. 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: (Michael McNulty)
If references are entirely missing, you can add them using this form.