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Real Exchange Rate Behavior: New Evidence with Linear and Non-linear Endogenous Break(s)

  • Chan, Tze-Haw
  • Chong, Lee Lee
  • Khong, Wye Leong Roy

Using monthly frequency data from 1981 to 2005, we test for the potential mean reversion of Japan-US real exchange rates using newly improved unit root tests allowing for endogenous (unknown) break(s) in the linear as well as non-linear manner. Both countries have contributed vital proportion in global trading on top of being the major trading partner to each other since 1960s. We identify structural breaks in 1985 and 1994 respectively via the Lumsdaine and Papell (1997)’s linear test, but the results were against the PPP hypothesis. The Saikkonen and LÄutkepohl, (2002)’s test, however, provides sufficient supports for non-linear adjustment of real exchange towards long run PPP. In addition, stronger evidence for PPP is found in the post-1994 period, in conjunction with the small persistence of real exchange deviations (half-life less than a year). Also, the exchange rate misalignment is less evident after the Plaza Accord 1985. In brief, our findings reveal that the Japanese authority has shown some form of PPP-oriented rule as a basis for their exchange rate policies, in the presence of structural break(s) and non-linearity.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 3406.

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Date of creation: 28 Apr 2008
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Handle: RePEc:pra:mprapa:3406
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  1. Lothian, James R. & Taylor, Mark P., 1997. "Real exchange rate behavior," Journal of International Money and Finance, Elsevier, vol. 16(6), pages 945-954, December.
  2. Liew, Venus Khim-sen & Baharumshah, Ahmad Zubaidi & Chong, Terence Tai-leung, 2004. "Are Asian real exchange rates stationary?," Economics Letters, Elsevier, vol. 83(3), pages 313-316, June.
  3. Menzie D. Chinn, 1998. "Before the Fall: Were East Asian Currencies Overvalued?," NBER Working Papers 6491, National Bureau of Economic Research, Inc.
  4. Papell, David H., 2002. "The great appreciation, the great depreciation, and the purchasing power parity hypothesis," Journal of International Economics, Elsevier, vol. 57(1), pages 51-82, June.
  5. Janine Aron & Ibrahim Elbadawi & Brian Kahn, 1998. "Determinants of the real exchange rate in South Africa," CSAE Working Paper Series 1997-16, Centre for the Study of African Economies, University of Oxford.
  6. Mototsugu Shintani, 2003. "A Nonparametric Measure of Convergence Toward Purchasing Power Parity," Levine's Working Paper Archive 506439000000000172, David K. Levine.
  7. Murray, Christian J. & Papell, David H., 2002. "The purchasing power parity persistence paradigm," Journal of International Economics, Elsevier, vol. 56(1), pages 1-19, January.
  8. Mark, Nelson C., 1990. "Real and nominal exchange rates in the long run: An empirical investigation," Journal of International Economics, Elsevier, vol. 28(1-2), pages 115-136, February.
  9. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
  10. Lanne, Markku & Lütkepohl, Helmut & Saikkonen, Pentti, 2001. "Test procedures for unit roots in time series with level shifts at unknown time," SFB 373 Discussion Papers 2001,39, Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes.
  11. Saikkonen, Pentti & Lütkepohl, Helmut, 1999. "Testing for a unit root in a time series with a level shift at unknown time," SFB 373 Discussion Papers 1999,72, Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes.
  12. Baharumshah, Ahmad Zubaidi & Aggarwal, Raj & Chan, Tze-Haw, 2005. "East Asian Real Exchange Rates and PPP: New Evidence from panel-data tests," MPRA Paper 2023, University Library of Munich, Germany, revised 2007.
  13. Hakkio, Craig S., 1984. "A re-examination of purchasing power parity : A multi-country and multi-period study," Journal of International Economics, Elsevier, vol. 17(3-4), pages 265-277, November.
  14. Wu, Yangru, 1996. "Are Real Exchange Rates Nonstationary? Evidence from a Panel-Data Test," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(1), pages 54-63, February.
  15. 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.
  16. Ben-David, Dan & Lumsdaine, Robin L & Papell, David, 1996. "The Unit Root Hypothesis in Long-term Output: Evidence from Two Structural Breaks for 16 Countries," CEPR Discussion Papers 1336, C.E.P.R. Discussion Papers.
  17. Bahmani-Oskooee, Mohsen, 1993. "Purchasing power parity based on effective exchange rate and cointegration: 25 LDCs' experience with its absolute formulation," World Development, Elsevier, vol. 21(6), pages 1023-1031, June.
  18. Aggarwal, Raj & Mougoue, Mbodja, 1996. "Cointegration among Asian currencies: Evidence of the increasing influence of the Japanese yen," Japan and the World Economy, Elsevier, vol. 8(3), pages 291-308, September.
  19. Lucrezia Reichlin & Peter Rappoport, 1989. "Segmented trends and non-stationary time series," ULB Institutional Repository 2013/10169, ULB -- Universite Libre de Bruxelles.
  20. Mark P. Taylor, 2003. "Purchasing Power Parity," Review of International Economics, Wiley Blackwell, vol. 11(3), pages 436-452, 08.
  21. Robin L. Lumsdaine & David H. Papell, 1997. "Multiple Trend Breaks And The Unit-Root Hypothesis," The Review of Economics and Statistics, MIT Press, vol. 79(2), pages 212-218, May.
  22. Papell, David H., 1997. "Searching for stationarity: Purchasing power parity under the current float," Journal of International Economics, Elsevier, vol. 43(3-4), pages 313-332, November.
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