A Non-linear Model of the Real US-UK Exchange Rate

John Creedy, Jeanette Lye and Vance Martin

Journal of Applied Econometrics, 1996, vol. 11, issue 6, 669-86

Abstract: This paper provides a framework for building and estimating non-linear real exchange rate models. The approach derives the stationary distribution from a continuous time error correction model and estimates this by MLE methods. The derived distribution exhibits a wide variety of distributional shapes including multimodality. The main result is that swings in the US/UK rate over the period 1973:3 to 1990:5 can be attributed to the distribution becoming bimodal with the rate switching between equilibria. By capturing these changes in the distribution, the non-linear model yields improvements over the random walk, the speculative efficiency model, and Hamilton's stochastic segmented trends model. Copyright 1996 by John Wiley & Sons, Ltd.

Date: 1996
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