The Law of One Price: Nonlinearities in Sectoral Real Exchange Rate Dynamics

Luciana Juvenal and Mark Taylor
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Luciana Juvenal: University of Warwick

No 80, Money Macro and Finance (MMF) Research Group Conference 2006 from Money Macro and Finance Research Group

Abstract: Using Self-Exciting Threshold Autoregressive Models (SETAR), this paper explores the validity of the Law of One Price (LOOP) for nineteen sectors in ten European countries. We find strong evidence of nonlinear mean reversion in deviations from the LOOP. We highlight the importance of modelling the real exchange rate in a nonlinear fashion in an attempt to solve the PPP Puzzle. Using the US dollar as a reference currency, half-life estimates range from nine to sixteen months (country averages), which are significantly lower than the `consensus estimates' of three to five years. The results also show that transaction costs differ enormously across sectors and countries

Keywords: Law of One Price; mean reversion; nonlinearities; thresholds (search for similar items in EconPapers)
JEL-codes: C22 F31 F41 (search for similar items in EconPapers)
Date: 2007-02-02
New Economics Papers: this item is included in nep-cba, nep-ets and nep-ifn
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:mmf:mmfc06:80

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