Threshold Adjustment in Deviations from the Law of One Price

FRB of St. Louis Working Paper No. 2008-027A

42 Pages Posted: 21 Aug 2008

See all articles by Luciana Juvenal

Luciana Juvenal

University of Warwick - Department of Economics

Mark P. Taylor

Barclays - Barclays Global Investors (London)

Date Written: August 20, 2008

Abstract

Using self-exciting threshold autoregressive models, we explore the validity of the law of one price (LOOP) for sixteen sectors in nine European countries. We and strong evidence of nonlinear mean reversion in deviations from the LOOP and highlight the importance of modelling the real exchange rate in a nonlinear fashion in an attempt to measure speeds of real exchange rate adjustment. Using the US dollar as a reference currency, the half-lives of sectoral real exchange rates shocks, calculated by Monte Carlo integration, imply much faster adjustment than the consensus half-life estimates of three to five years. The results also imply that transaction costs vary significantly across sectors and countries.

Keywords: Law of One Price, mean reversion, nonlinearities, thresholds

JEL Classification: F31, F41, C22

Suggested Citation

Juvenal, Luciana and Taylor, Mark P., Threshold Adjustment in Deviations from the Law of One Price (August 20, 2008). FRB of St. Louis Working Paper No. 2008-027A, Available at SSRN: https://ssrn.com/abstract=1241019 or http://dx.doi.org/10.2139/ssrn.1241019

Luciana Juvenal (Contact Author)

University of Warwick - Department of Economics ( email )

Coventry CV4 7AL
United Kingdom

Mark P. Taylor

Barclays - Barclays Global Investors (London) ( email )

Murray House
Royal Mint Court
EC3N 4HH London
United Kingdom

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