Examining exchange rate bubbles in Pakistan: application of sequential ADF tests

Muhammad Jawad (), Sidra Nazir () and Md. Saiful Islam ()
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Muhammad Jawad: Data Scientist, Federal SDGs Support Unit, Ministry of Planning Development and Special Initiatives
Sidra Nazir: Arid Agriculture University
Md. Saiful Islam: University of Hail

SN Business & Economics, 2025, vol. 5, issue 9, 1-24

Abstract: Abstract Exchange rate dynamics are pivotal in shaping a nation’s economic landscape, influencing key indicators like trade balances, foreign direct investment, and overall economic performance. The evidence regarding rational bubbles in foreign exchange markets remains inconclusive. Identifying rational bubbles in currency exchange rates is crucial for preventing financial instability and informing effective monetary policy, thereby ensuring that exchange rates align with economic fundamentals. This paper applies the sequential unit root, that is, Generalized Supremum Augmented Dickey-Fuller (GSADF) test, to identify rational bubbles in exchange rate (nominal) daily data from July 03, 2000, to September 30, 2024. Our findings reveal strong evidence of explosive behavior in the PKR/AED, PKR/EUR, PKR/GBP, PKR/SAR, PKR/USD, and PKR/CNY exchange rates. The study reveals that the periods of bubbles in the PKR/AED, PKR/SAR, and PKR/USD exchange rates exhibit similar patterns and often coincide with market trends. However, the periods of no bubble (or bust) in the PKR/EUR and PKR/GBP exchange rates remain longer than those of others. Such fluctuations in the exchange rate indicate potential instability in upcoming trade contracts. To prevent future exchange rate volatility, policymakers should integrate bubble-detection tools, such as GSADF, into their exchange rate monitoring to preempt speculative surges. Transparent communication of monetary and fiscal policy can reduce uncertainty-driven volatility. Additionally, diversifying currency exposure through bilateral settlements and temporarily restricting forex investment flows during bubble periods can help mitigate destabilizing shocks.

Keywords: Bubble detection; Exchange rate volatility; GSADF Test; Pakistani rupee; Financial stability; Monetary policy (search for similar items in EconPapers)
JEL-codes: C22 E52 F31 G01 (search for similar items in EconPapers)
Date: 2025
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DOI: 10.1007/s43546-025-00896-7

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