Detecting Mean Reversion in Real Exchange Rates from a Multiple Regime STAR Model

Frédérique Bec · Mélika Ben Salem · Marine Carrasco

43 citations0/0 files storedAnnals of Economics and Statistics

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Monetary Policy and Economic Impact Financial Markets and Investment Strategies Economic theories and models

Abstract

Recent studies on general equilibrium models with transaction costs show that the dynamics of the real exchange rate are necessarily nonlinear. Our contribution to the literature on nonlinear price adjustment mechanisms is threefold. First, we model the real exchange rate by a Multi-Regime Logistic Smooth Transition AutoRegression (MR-LSTAR), allowing for both ESTAR-type and SETAR-type dynamics. This choice is motivated by the fact that even the theoretical models, which predict a smooth behavior for the real exchange rate, do not rule out the possibility of a discontinuous adjustment as a limit case. Second, we propose two classes of unit-root tests against this MR-LSTAR alternative, based respectively on the likelihood and on an auxiliary model. Their asymptotic distributions are derived analytically. Third, when applied to 28 bilateral real exchange rates, our tests reject the null hypothesis of a unit root for eleven series bringing evidence in favor of the purchasing power parity.

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References

1981Likelihood Ratio Statistics for Autoregressive Time Series with a Unit Root 1992Testing the null hypothesis of stationarity against the alternative of a unit root 1991Heteroskedasticity and Autocorrelation Consistent Covariance Matrix Estimation 1996The Purchasing Power Parity Puzzle 1996Inference When a Nuisance Parameter Is Not Identified Under the Null Hypothesis 1991Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis 2002Testing for a unit root in the nonlinear STAR framework 1988Testing Linearity Against Smooth Transition Autoregressive Models

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