Nonlinear Mean-Reversion in Real Exchange Rates: Towards a Solution to the Purchasing Power Parity Puzzles

Mark Taylor, David Peel and Lucio Sarno

No 2658, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We fit nonlinearly mean-reverting models to real dollar exchange rates over the post-Bretton Woods period, consistent with a theoretical literature on transaction costs in international arbitrage. The half lives of real exchange rate shocks, calculated through Monte Carlo integration, imply faster adjustment speeds than hitherto recorded. Monte Carlo simulations reconcile our results with the large empirical literature on unit roots in real exchange rates by showing that when the real exchange rate is nonlinearly mean reverting, standard univariate unit root tests have low power, while multivariate tests have much higher power to reject a false null hypothesis

Keywords: Unit root test; Test power; Purchasing power parity; Real exchange rate; Nonlinear dynamics (search for similar items in EconPapers)
JEL-codes: C10 F31 F41 (search for similar items in EconPapers)
Date: 2001-01
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Citations: View citations in EconPapers (740)

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Journal Article: Nonlinear Mean-Reversion in Real Exchange Rates: Toward a Solution to the Purchasing Power Parity Puzzles (2001)
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