MODELLING THE US/UK REAL EXCHANGE RATE-REAL INTEREST RATE DIFFERENTIAL RELATION: A MULTIVARIATE REGIME SWITCHING APPROACH

Angelos Kanas

Manchester School, 2005, vol. 73, issue 2, pages 123-140

Abstract: This paper investigates the empirical link between the US/UK real exchange rate and real interest differential for the period 1959-2002, using a bivariate Markov switching vector autoregression model. We find strong evidence of volatility regime switching in the US/UK real exchange rate-real interest differential relation. There is also evidence of a regime-dependent dynamic link. These findings indicate that allowing for multivariate regime switching can reconcile theoretical models of exchange rates which predict a strong link between real exchange rates and the real interest differential, and previous empirical evidence which failed to uncover such a link. Copyright Blackwell Publishing Ltd and The University of Manchester, 2005.

Date: 2005
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