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Drifting STAR: A Time-Varying Nonlinear Real Exchange Rate Analysis

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  • Efthymios Pavlidis
  • Nicos Pavlidis

Abstract

Nonlinear real exchange rate models are typically based on the assumption of time-invariant market frictions. In this paper, we propose a time-varying-parameter smooth transition autoregressive model that facilitates inference on the evolution of market frictions and real exchange rate volatility. Using a long-span monthly dataset on the dollar–sterling real exchange rate that covers more than two centuries, we estimate the model in a fully Bayesian framework via Hamiltonian Monte Carlo. Our results provide evidence of long swings in the degree of market frictions over time. Furthermore, we show that real exchange rate volatility has exhibited large and persistent movements. These movements can be partially attributed to changes in the exchange rate regime. Finally, a generalized impulse response analysis indicates that the speed of real exchange rate adjustment to shocks varies substantially across historical periods.

Suggested Citation

  • Efthymios Pavlidis & Nicos Pavlidis, 2025. "Drifting STAR: A Time-Varying Nonlinear Real Exchange Rate Analysis," Working Papers 429842484, Lancaster University Management School, Economics Department.
    • Handle: RePEc:lan:wpaper:429842484
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