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Modeling exchange rate dynamics in Peru: A cointegration approach using the UIP and PPP

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  • Jaramillo Franco, Miguel
  • Serván Lozano, Sergio

Abstract

This paper investigates whether the Purchasing Power Parity (PPP) and the Uncovered Interest Rate Parity (UIP) hold for the Peruvian economy. We analyze Peruvian, international and trade-weighted foreign data for the period 1997 - 2011 using Johansen's cointegration approach. The results of our analysis suggest the existence of two stationary relations obtained after imposing overidentifying restrictions, which represent a combination of the UIP with the PPP and an equation for an augmented risk premium. In terms of monetary policy, our findings provide evidence that the aim of the Central Bank's intervention in the currency market is to smooth short-run volatility of the exchange rate, but does not have a long-run effect. After a successful identification of the stationary relations, we develop a permanent-transitory analysis following Gonzalo & Ng (2001) in order to analyze the impact of structural shocks to the error correction model variables and some relations of interest.

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  • Jaramillo Franco, Miguel & Serván Lozano, Sergio, 2012. "Modeling exchange rate dynamics in Peru: A cointegration approach using the UIP and PPP," MPRA Paper 70772, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:70772
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    More about this item

    Keywords

    PPP; UIP; cointegration; Johansen; exchange rate; impulse responses; permanent and transitory shocks.;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F30 - International Economics - - International Finance - - - General
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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