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Nonlinearity and structural breaks in Irish PPP relationships: an application of random field regression

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  • Derek Bond
  • Michael Harrison
  • Edward O'Brien

Abstract

Using nominal and real exchange rates for Ireland relative to Germany and the UK from 1975 to 2003, this article explores likely sources of nonlinearity in Purchasing Power Parity (PPP) relationships and difficulties in employing an I(1)/I(0) econometric framework. Tests for fractional integration and nonlinearity, including random field regression-based procedures, are applied. Results reveal shortcomings in the standard cointegration and smooth transition autoregression approaches to modelling, and point to multiple structural changes models. Such a model for the case of Ireland and Germany suggests that PPP holds not only in the long-run but also in the medium to short term.

Suggested Citation

  • Derek Bond & Michael Harrison & Edward O'Brien, 2011. "Nonlinearity and structural breaks in Irish PPP relationships: an application of random field regression," Applied Economics, Taylor & Francis Journals, vol. 43(15), pages 1899-1911.
  • Handle: RePEc:taf:applec:v:43:y:2011:i:15:p:1899-1911
    DOI: 10.1080/00036840902780144
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    1. Paul Cashin & C. John McDermott, 2006. "Parity Reversion in Real Exchange Rates: Fast, Slow, or Not at All?," IMF Staff Papers, Palgrave Macmillan, vol. 53(1), pages 1-5.
    2. Schnatz, Bernd, 2006. "Is reversion to PPP in euro exchange rates non-linear?," Working Paper Series 682, European Central Bank.
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