An asymmetrical overshooting correction model for G20 nominal effective exchange rates

This paper develops an asymmetrical overshooting correction autoregressive model to capture excessive nominal exchange rate variation. It is based on the widely accepted perception that open economies might react differently to under-evaluation or over-evaluation of their currency because of the trade-off between fostering their net exports and maintaining their international purchasing power. Our approach departs from existing works by considering explicitly both size and sign effects: the strength of the overshooting correction mechanism is indeed allowed to differ between large and small depreciations and appreciations. Evidence of overshooting correction is found in most G20 countries. Formal statistical tests confirm sign and/or size asymmetry of the overshooting correction mechanism in most countries. It turns out that the overshooting correction specification is heterogeneous among countries, even though most of Emerging Market and Developing Economies are found to adjust to over-depreciation whereas the Euro Area and the US are shown to adjust to over-appreciation only.