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Smooth Breaks And Nonlinear Mean Reversion In Real Interest Parity: Evidence From East Asian Countries

Author

Listed:
  • Abdullah Gulcu

    () (Department of Economics, Middle East Technical University, Ankara, Turkey)

  • Dilem Yildirim

    () (Department of Economics, Middle East Technical University, Ankara, Turkey)

Abstract

This study aims to explore the empirical validity of the real interest rate parity (RIP) hypothesis for East Asian countries using Japan as the base country. To this end, we employ the recently proposed unit root tests of Christopoulos and Leon-Ledesma (2010) that account for both multiple smooth structural breaks of unknown form and nonlinear mean reversion in the series. Our empirical results uncover overwhelming evidences in favor of the RIP hypothesis for the whole countries in our sample. More specifically, through a Fourier approximation, it is observed that all real interest rate differentials display a mean reverting behavior around an infrequently smooth-breaking mean, with the breaks being in accordance with the financial reforms and economic crises witnessed by the countries. Moreover, the degree of mean reversion appears to vary nonlinearly with the size of real interest rate appreciations and depreciations.

Suggested Citation

  • Abdullah Gulcu & Dilem Yildirim, 2018. "Smooth Breaks And Nonlinear Mean Reversion In Real Interest Parity: Evidence From East Asian Countries," ERC Working Papers 1804, ERC - Economic Research Center, Middle East Technical University, revised Feb 2018.
  • Handle: RePEc:met:wpaper:1804
    as

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    File URL: http://erc.metu.edu.tr/en/system/files/menu/series18/1804.pdf
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    References listed on IDEAS

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    Keywords

    Real Interest Rate Parity; Financial Integration; Nonlinearity; Smooth Structural Breaks; East Asian Countries;

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • F40 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - General
    • G01 - Financial Economics - - General - - - Financial Crises

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