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Threshold adjustment in deviations from the law of one price

Listed author(s):
  • Luciana Juvenal
  • Mark P. Taylor

Using self-exciting threshold autoregressive models, we explore the validity of the law of one price (LOOP) for sixteen sectors in nine European countries. We and strong evidence of nonlinear mean reversion in deviations from the LOOP and highlight the importance of modelling the real exchange rate in a nonlinear fashion in an attempt to measure speeds of real exchange rate adjustment. Using the US dollar as a reference currency, the half-lives of sectoral real exchange rates shocks, calculated by Monte Carlo integration, imply much faster adjustment than the consensus half-life estimates of three to five years. The results also imply that transaction costs vary significantly across sectors and countries.

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File URL: http://research.stlouisfed.org/wp/2008/2008-027.pdf
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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2008-027.

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Date of creation: 2008
Publication status: Published in Studies in Nonlinear Dynamics and Econometrics, September 2008, 12(3)
Handle: RePEc:fip:fedlwp:2008-027
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