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The Behaviour of the Real Exchange Rate: A Re-examination Using Finite Sample Approach

Author

Listed:
  • Kuo, Biing-Shen
  • Mikkola, Anne

Abstract

The results of this paper complement the recent findings of real exchange rates as stationary processes. The standard procedure of applying a battery of unit root tests can be problematic since the tests are sensitive to the specifics of the time-series process. The novelty of the approach we applied in this paper is in emphasizing the information content of the data in distinguishing between the competing processes. Stationary and non-stationary ARIMA processes are fitted to the US/UK real exchange rate series covering 134 years. Artificial data following these two processes are generated, and the small sample distributions of the chosen test statistics (including the most powerful point optimal tests with both the unit root and the stationarity as a null) are computed under each of the two hypotheses. The values of the actual sample statistics are shown to be more likely to come from the stationary process than from the non-stationary one.

Suggested Citation

  • Kuo, Biing-Shen & Mikkola, Anne, 1997. "The Behaviour of the Real Exchange Rate: A Re-examination Using Finite Sample Approach," CEPR Discussion Papers 1716, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:1716
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    More about this item

    Keywords

    Purchasing Power Parity; Real Exchange Rate; Unit Root;

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation: Models and Applications

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