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Searching for Nonlinearities in Real Exchange Rates?

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  • Yamin Ahmad

    (Department of Economics, University of Wisconsin - Whitewater)

  • Stuart Glosser

    (Department of Economics, University of Wisconsin - Whitewater)

Abstract

A recent innovation in modeling exchange rates has been the use of nonlinear techniques such as threshold autoregressive models and its smooth transition variants. This paper investigates the smooth transition autoregressive (STAR) modeling strategy in an application to real exchange rates. The key findings are as follows. First, using the methodology advocated by Teräsvirta (1994), we find evidence of nonlinear dynamics for several of the spot dollar real exchange rates using monthly data on five of the G7 countries. However, once estimated, we find that the STAR specification is appropriate for only one of the three exchange rate series indicated to be an ESTAR process. Moreover, using simulations, we show that the underlying methodology used to detect nonlinearities in the data exhibit substantial size biases, which we attribute to influential observations. We also investigate an alternative nonlinear specification and find that we can model the dollar-sterling and the dollar-lira real exchange rates better as an open-loop TAR process instead of a SETAR process.

Suggested Citation

  • Yamin Ahmad & Stuart Glosser, 2007. "Searching for Nonlinearities in Real Exchange Rates?," Working Papers 09-01, UW-Whitewater, Department of Economics, revised Jan 2009.
  • Handle: RePEc:uww:wpaper:09-01
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    Cited by:

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    3. Ahmad, Yamin & Craighead, William D., 2011. "Temporal aggregation and purchasing power parity persistence," Journal of International Money and Finance, Elsevier, vol. 30(5), pages 817-830, September.
    4. Arif Orçun Söylemez, 2022. "Volatility dependent smooth transitions and abrupt switches: why they are needed for better forecasting the FX rates," Eurasian Economic Review, Springer;Eurasia Business and Economics Society, vol. 12(2), pages 315-332, June.

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    More about this item

    Keywords

    Nonlinear Models of Exchange Rates; Threshold Models; ESTAR; TAR; PPP;
    All these keywords.

    JEL classification:

    • F30 - International Economics - - International Finance - - - General

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