Nonlinear mean-reversion in real exchange rates: towards a solution to the purchasing power parity puzzles
Taylor, Mark P., 1958-, Peel, D. and Sarno, Lucio (2001) Nonlinear mean-reversion in real exchange rates: towards a solution to the purchasing power parity puzzles. Discussion Paper. London: Centre for Economic Policy Research (Great Britain). Discussion paper (Centre for Economic Policy Research (Great Britain)) (No.265).
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We fit nonlinearly mean-reverting models to real dollar exchange rates over the post-Bretton Woods period, consistent with a theoretical literature on transaction costs in international arbitrage. The half lives of real exchange rate shocks, calculated through Monte Carlo integration, imply faster adjustment speeds than hitherto recorded. Monte Carlo simulations reconcile our results with the large empirical literature on unit roots in real exchange rates by showing that when the real exchange rate is nonlinearly mean reverting, standard univariate unit root tests have low power, while multivariate tests have much higher power to reject a false null hypothesis.
|Item Type:||Working or Discussion Paper (Discussion Paper)|
|Subjects:||H Social Sciences > HG Finance|
|Divisions:||Faculty of Social Sciences > Economics|
|Library of Congress Subject Headings (LCSH):||Purchasing power parity, Foreign exchange rates -- Mathematical models, Nonlinear theories, Statistics|
|Series Name:||Discussion paper (Centre for Economic Policy Research (Great Britain))|
|Publisher:||Centre for Economic Policy Research (Great Britain)|
|Place of Publication:||London|
|Official Date:||January 2001|
|Number of Pages:||40|
|Status:||Not Peer Reviewed|
|Access rights to Published version:||Open Access|
|Funder:||Leverhulme Trust (LT)|
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