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Goods Arbitrage and Real Exchange Rate Stationarity

Recent evidence suggests that while real exchange rates exhibit mean reversion, the reversion only sets in once a minimum "threshold" distance from the mean has been exceeded. The non-linearity has generally been attributed to costly arbitrage, which requires a minimum divergence before the costs of arbitrage can be recouped. In this paper, we examine this reasoning. If arbitrage was indeed the cause of mean reversion, one would expect to see a quantity respose of trade flows at the thresholds. We conduct an array of formal and informal tests of the presence of such quantity responses. We fail to unearth any significant evidence of trade flows changing at the points of mean reversion. Alternative explanations of mean reversion, notably exchange market intervention, would thus seem to warrant further attention.

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File URL: http://www.oenb.at/dms/oenb/Publikationen/Volkswirtschaft/Working-Papers/1998/Working-Paper-29/fullversion/wp29_tcm16-6096.pdf
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Paper provided by Oesterreichische Nationalbank (Austrian Central Bank) in its series Working Papers with number 29.

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Length: 24
Date of creation: 30 Jun 1998
Date of revision:
Handle: RePEc:onb:oenbwp:29
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  1. Robert E. Cumby, 1996. "Forecasting Exchange Rates and Relative Prices with the Hamburger Standard: Is What You Want What You Get With McParity?," NBER Working Papers 5675, National Bureau of Economic Research, Inc.
  2. Obstfeld, Maurice & Taylor, Alan M., 1997. "Nonlinear Aspects of Goods-Market Arbitrage and Adjustment: Heckscher's Commodity Points Revisited," Journal of the Japanese and International Economies, Elsevier, vol. 11(4), pages 441-479, December.
  3. Kenneth A. Froot & Kenneth Rogoff, 1994. "Perspectives on PPP and Long-Run Real Exchange Rates," NBER Working Papers 4952, National Bureau of Economic Research, Inc.
  4. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
  5. Charles Engel & Michael K. Hendrickson & John H. Rogers, 1997. "Intra-National, Intra-Continental, and Intra-Planetary PPP," NBER Working Papers 6069, National Bureau of Economic Research, Inc.
  6. Benninga, Simon & Protopapadakis, Aris, 1988. "The equilibrium pricing of exchange rates and assets when trade takes time," Journal of International Money and Finance, Elsevier, vol. 7(2), pages 129-149, June.
  7. Parsley, David C & Wei, Shang-Jin, 1996. "Convergence to the Law of One Price without Trade Barriers or Currency Fluctuations," The Quarterly Journal of Economics, MIT Press, vol. 111(4), pages 1211-36, November.
  8. Isard, Peter, 1977. "How Far Can We Push the "Law of One Price"?," American Economic Review, American Economic Association, vol. 67(5), pages 942-48, December.
  9. Shang-Jin Wei & David C. Parsley, 1995. "Purchasing Power Disparity During the Floating Rate Period: Exchange Rate Volatility, Trade Barriers and Other Culprits," NBER Working Papers 5032, National Bureau of Economic Research, Inc.
  10. Dumas, Bernard, 1992. "Dynamic Equilibrium and the Real Exchange Rate in a Spatially Separated World," Review of Financial Studies, Society for Financial Studies, vol. 5(2), pages 153-80.
  11. Mark P. Taylor, 2003. "Purchasing Power Parity," Review of International Economics, Wiley Blackwell, vol. 11(3), pages 436-452, 08.
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