The inadequacy of linear autoregressive model for real exchange rates: empirical evidence from Asian economies

Venus Khim‐Sen Liew · Terence Tai‐Leung Chong · Kian‐Ping Lim

65 citations0/0 files storedApplied Economics

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Abstract

Utilizing the formal linearity test of Luukkonen, Saikkonen and Teräsvirta (Biometrika, 75, 491-499, 1998) as diagnostic tool, the empirical finding suggests that the linear autoregressive (AR) model is inadequate in describing the real exchange rates behaviour of 11 Asian economies. It is noted that the conventional battery of diagnostic tests is capable of identifying the inadequacy of the linear model in only three of these series. Moreover, the linearity nature of this behaviour has been formally rejected in favour of the non-linear smooth transition autoregressive (STAR) model. The finding of non-linearity in the data generating process of these real exchange rates warrants that the use of linear framework in empirical modelling and statistical testing procedures in the field of exchange rates may lead to an inappropriate policy conclusions.

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References

1988Testing Linearity Against Smooth Transition Autoregressive Models 2002SMOOTH TRANSITION AUTOREGRESSIVE MODELS — A SURVEY OF RECENT DEVELOPMENTS 2001Nonlinear Mean‐Reversion in Real Exchange Rates: Toward a Solution To the Purchasing Power Parity Puzzles 1992Characterizing nonlinearities in business cycles using smooth transition autoregressive models 2000Nonlinear adjustment, long-run equilibrium and exchange rate fundamentals 1977Forecasting and time series analysis 2001Nonlinear adjustment to purchasing power parity in the post-Bretton Woods era 1999Modeling non-linearities in real effective exchange rates

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