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Nonlinear Adjustment in Real Exchange Rates and Long Run Purchasing Power Parity--Further Evidence

  • Darbha, Gangadhar

    (U of Pennsylvania)

  • Patel, Urjit R.

    (Infrastructure Development Finance Corporation)

Registered author(s):

    The paper investigates, using a threshold autoregression model, the nature of nonlinear adjustments in real exchange rates (RERs) arising from the presence of transaction costs and uncertainty, and their implications for the testing of unit roots. Using monthly data for the U.S. vis-a-vis 19 trading partners we find that most RERs are better characterized by a mean reverting nonlinear stochastic process, with large changes converging faster than small changes, implying that there is convergence towards PPP equilibrium at least in the long-run, albeit in a non-linear manner. It is found that, across countries and commodity groups, there is an association between geographical and trade related proximity and the estimated speeds of adjustment. In addition, policy agreements that mitigate exchange rate uncertainty such as the Louvre Accord could have contributed to greater international commodity arbitrage.

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    Paper provided by University of Pennsylvania, Wharton School, Weiss Center in its series Working Papers with number 04-1.

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    Date of creation: Mar 2004
    Date of revision:
    Handle: RePEc:ecl:upafin:04-1
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    7. Cheung, Yin-Wong & Chinn, Menzie & Fujii, Eiji, 2001. "Market Structure and the Persistence of Sectoral Real Exchange Rates," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 6(2), pages 95-114, April.
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    9. Corbae, Dean & Ouliaris, Sam, 1988. "Cointegration and Tests of Purchasing Power Parity," The Review of Economics and Statistics, MIT Press, vol. 70(3), pages 508-11, August.
    10. Grilli, Vittorio & Kaminsky, Graciela, 1991. "Nominal exchange rate regimes and the real exchange rate : Evidence from the United States and Great Britain, 1885-1986," Journal of Monetary Economics, Elsevier, vol. 27(2), pages 191-212, April.
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    14. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
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    16. Michael, Panos & Nobay, A Robert & Peel, David A, 1997. "Transactions Costs and Nonlinear Adjustment in Real Exchange Rates: An Empirical Investigation," Journal of Political Economy, University of Chicago Press, vol. 105(4), pages 862-79, August.
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    20. Huizinga, John, 1987. "An empirical investigation of the long-run behavior of real exchange rates," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 27(1), pages 149-214, January.
    21. McKenzie, Michael D, 1999. " The Impact of Exchange Rate Volatility on International Trade Flows," Journal of Economic Surveys, Wiley Blackwell, vol. 13(1), pages 71-106, February.
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    23. Delgado, Francisco A., 1991. "Hysteresis, menu costs, and pricing with random exchange rates," Journal of Monetary Economics, Elsevier, vol. 28(3), pages 461-484, December.
    24. Pippenger, Michael K & Goering, Gregory E, 1993. "A Note on the Empirical Power of Unit Root Tests under Threshold Processes," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 55(4), pages 473-81, November.
    25. Jose A. Lopez, 1996. "Exchange rate cointegration across central bank regime shifts," Research Paper 9602, Federal Reserve Bank of New York.
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