Nonlinear Adjustment in Real Exchange Rates and Long Run Purchasing Power Parity--Further Evidence

Gangadhar Darbha and Urjit R. Patel
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Gangadhar Darbha: U of Pennsylvania
Urjit R. Patel: Infrastructure Development Finance Corporation

Working Papers from University of Pennsylvania, Wharton School, Weiss Center

Abstract: The paper investigates, using a threshold autoregression model, the nature of nonlinear adjustments in real exchange rates (RERs) arising from the presence of transaction costs and uncertainty, and their implications for the testing of unit roots. Using monthly data for the U.S. vis-a-vis 19 trading partners we find that most RERs are better characterized by a mean reverting nonlinear stochastic process, with large changes converging faster than small changes, implying that there is convergence towards PPP equilibrium at least in the long-run, albeit in a non-linear manner. It is found that, across countries and commodity groups, there is an association between geographical and trade related proximity and the estimated speeds of adjustment. In addition, policy agreements that mitigate exchange rate uncertainty such as the Louvre Accord could have contributed to greater international commodity arbitrage.

JEL-codes: C32 (search for similar items in EconPapers)
Date: 2004-03
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