Smooth Breaks and Nonlinear Mean Reversion: Post-Bretton Woods Real Exchange Rates

Dimitris Christopoulos and Miguel Leon-Ledesma

MPRA Paper from University Library of Munich, Germany

Abstract: The recent literature on Purchasing Power Parity (PPP) has emphasized the role of two phenomena that may lead to the rejection of the PPP hypothesis: structural breaks and nonlinear adjustment induced by transaction costs. These two hypotheses are analyzed separately in the literature. We develop tests for unit roots that account jointly for structural breaks and nonlinear adjustment. Structural breaks are modeled by means of a Fourier function that allows for infrequent smooth temporary mean changes and is hence compatible with long-run PPP. Nonlinear adjustment is modeled by means of an ESTAR model. Our tests present good finite sample properties. The tests are applied to a set of 15 OECD countries’ RERs and are able to reject the null of a unit root in 14 cases. The breaks are usually associated with the great appreciation and later depreciation of the dollar in the 1980s and the ESTAR adjustment appears to play an important role.

Keywords: Fourier model; ESTAR; nonlinear adjustment; PPP (search for similar items in EconPapers)
JEL-codes: C22 F40 (search for similar items in EconPapers)
Date: 2009
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Citations: View citations in EconPapers (2)

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Related works:
Journal Article: Smooth breaks and non-linear mean reversion: Post-Bretton Woods real exchange rates (2010)
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:22553

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