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Threshold adjustment of deviations from the law of one price

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Juvenal, Luciana and Taylor, Mark P.. (2008) Threshold adjustment of deviations from the law of one price. Studies in Nonlinear Dynamics and Econometrics (Online), Vol.12 (No.3). Article 8. ISSN 1558-3708

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Official URL: http://dx.doi.org/10.2202/1558-3708.1520

Abstract

Using self-exciting threshold autoregressive models, we explore the validity of the law of one price (LOOP) for sixteen sectors in nine European countries. We find strong evidence of nonlinear mean reversion in deviations from the LOOP and highlight the importance of modelling the real exchange rate in a nonlinear fashion in an attempt to measure speeds of real exchange rate adjustment. Using the US dollar as a reference currency, the half-lives of sectoral real exchange rate shocks, calculated by Monte Carlo integration, imply much faster adjustment than the 'consensus' half-life estimates of three to five years. The results also imply that transaction costs vary significantly across sectors and countries.

Item Type:	Journal Article
Subjects:	H Social Sciences > HG Finance
Divisions:	Faculty of Social Sciences > Economics Faculty of Social Sciences > Warwick Business School > Finance Group Faculty of Social Sciences > Warwick Business School
Library of Congress Subject Headings (LCSH):	Purchasing power parity -- Europe, Purchasing power parity -- Mathematical models, Monte Carlo method, Foreign exchange rates
Journal or Publication Title:	Studies in Nonlinear Dynamics and Econometrics (Online)
Publisher:	Berkeley Electronic Press
ISSN:	1558-3708
Date:	2008
Volume:	Vol.12
Number:	No.3
Page Range:	Article 8
Identification Number:	10.2202/1558-3708.1520
Status:	Peer Reviewed
Access rights to Published version:	Open Access
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URI:	http://wrap.warwick.ac.uk/id/eprint/885