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Empirical Economics

, Volume 43, Issue 2, pp 457–474 | Cite as

What do we know about real exchange rate nonlinearities?

  • Robinson KruseEmail author
  • Michael Frömmel
  • Lukas Menkhoff
  • Philipp Sibbertsen
Article

Abstract

Nonlinear modeling of adjustments to purchasing power parity has recently gained much attention. However, a huge body of the empirical literature applies ESTAR models and neglects the existence of other competing nonlinear models. Among these, the Markov Switching AR model has a strong substantiation in international finance. Our contribution to the literature is fivefold: First, ESTAR and MSAR models from a unit root perspective are compared. To this end, a new unit root test against MSAR is proposed as the second contribution. Thirdly, the case of misspecified alternatives in a Monte Carlo setup with real world parameter constellations is studied. The ESTAR unit root test is not indicative, while the MSAR unit test is robust. Fourthly, the case of correctly specified alternatives is considered and low power of the ESTAR but not for the MSAR unit root test is observed. Fifthly, an empirical application to real exchange rates suggests that they may indeed be explained by Markov Switching dynamics rather than ESTAR.

Keywords

Real exchange rates Unit root test ESTAR Markov Switching PPP 

JEL Classification

C12 C22 F31 

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Copyright information

© Springer-Verlag 2010

Authors and Affiliations

  • Robinson Kruse
    • 1
    Email author
  • Michael Frömmel
    • 2
  • Lukas Menkhoff
    • 3
  • Philipp Sibbertsen
    • 4
  1. 1.School of Economics and ManagementAarhus University, CREATESAarhus CDenmark
  2. 2.Department of Financial EconomicsGhent UniversityGentBelgium
  3. 3.Department of Economics, Institute of Money and International FinanceLeibniz University HannoverHannoverGermany
  4. 4.Department of Economics, Institute of StatisticsLeibniz University HannoverHannoverGermany

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