What Do We Know About Real Exchange Rate Non-Linearities?

CREATES Research Paper 2009-50

27 Pages Posted: 29 Oct 2009

See all articles by Robinson Kruse

Robinson Kruse

Aarhus University

Michael Frömmel

Ghent University - Department of Financial Economics

Lukas Menkhoff

German Institute for Economic Research (DIW Berlin); Humboldt University of Berlin - Faculty of Economics

Philipp Sibbertsen

University of Hannover

Date Written: October 28, 2009

Abstract

This research points to the serious problem of potentially misspecified alternative hypotheses when testing for unit roots in real exchange rates. We apply a popular unit root test against nonlinear ESTAR and develop a Markov Switching unit root test. The empirical power of these tests against correctly and misspecified non-linear alternatives is analyzed by means of a Monte Carlo study. The chosen parametrization is obtained by real-life exchange rates. The test against ESTAR has low power against all alternatives whereas the proposed unit root test against a Markov Switching autoregressive model performs clearly better. An empirical application of these tests suggests that real exchange rates may indeed be explained by Markov-Switching dynamics.

Keywords: real exchange rates, unit root test, ESTAR, Markov Switching, PPP

JEL Classification: C12, C22, F31

Suggested Citation

Kruse, Robinson and Frömmel, Michael and Menkhoff, Lukas and Sibbertsen, Philipp, What Do We Know About Real Exchange Rate Non-Linearities? (October 28, 2009). CREATES Research Paper 2009-50. Available at SSRN: https://ssrn.com/abstract=1495612 or http://dx.doi.org/10.2139/ssrn.1495612

Robinson Kruse (Contact Author)

Aarhus University ( email )

Nordre Ringgade 1
DK-8000 Aarhus C, 8000
Denmark

Michael Frömmel

Ghent University - Department of Financial Economics ( email )

Sint-Pietersplein 5
Ghent, 9000
Belgium

Lukas Menkhoff

German Institute for Economic Research (DIW Berlin) ( email )

Mohrenstraße 58
Berlin, 10117
Germany

Humboldt University of Berlin - Faculty of Economics ( email )

Spandauer Strasse 1
Berlin
Germany

Philipp Sibbertsen

University of Hannover ( email )

Welfengarten 1
D-30167 Hannover, 30167
Germany

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