The Dollar Exchange Rate, Adjustment to the Purchasing Power Parity, and the Interest Rate Differential
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This study applies a Markov switching error correction model to describe the single most important real exchange rate (Deutsche mark versus US dollar) over the flexible exchange rates period from 1973 to 2004. We show an alternative way of modelling non-linear adjustment to the purchasing power parity (PPP) besides standard threshold models. The model merges the two possible sources of non-linearity by additionally allowing the probability of a mean-reverting regime to increase with the distance from PPP. The interest rate differential as an additional determinant of real exchange rate behaviour in a Markov switching framework is introduced in the model. The study finds that the real dollar exchange rate during the post-Bretton Woods era is well described by a Markov switching error correction model with (PPP) as long-run equilibrium. There is one mean reversion regime where PPP and the interest parity condition are valid. Contrary, the second regime is characterised by persistent mean... aversion, where a regime switch does not become more likely with increasing distance from PPP. The unconditional half-life of shocks is about 1.5 years.
Кључне речи:
real exchange rate modelling / purchasing power parity / interest rate differentials / non-linearities / error correction modelИзвор:
Mathematics, 2022, 10, 23, 4504-Издавач:
- MDPI AG
Институција/група
Географски институт „Јован Цвијић“ САНУ / Geographical Institute Jovan Cvijić SASATY - JOUR AU - Frömmel, Michael AU - Vukovic, Darko B. AU - Wu, Jinyuan PY - 2022 UR - https://dais.sanu.ac.rs/123456789/14044 AB - This study applies a Markov switching error correction model to describe the single most important real exchange rate (Deutsche mark versus US dollar) over the flexible exchange rates period from 1973 to 2004. We show an alternative way of modelling non-linear adjustment to the purchasing power parity (PPP) besides standard threshold models. The model merges the two possible sources of non-linearity by additionally allowing the probability of a mean-reverting regime to increase with the distance from PPP. The interest rate differential as an additional determinant of real exchange rate behaviour in a Markov switching framework is introduced in the model. The study finds that the real dollar exchange rate during the post-Bretton Woods era is well described by a Markov switching error correction model with (PPP) as long-run equilibrium. There is one mean reversion regime where PPP and the interest parity condition are valid. Contrary, the second regime is characterised by persistent mean aversion, where a regime switch does not become more likely with increasing distance from PPP. The unconditional half-life of shocks is about 1.5 years. PB - MDPI AG T2 - Mathematics T1 - The Dollar Exchange Rate, Adjustment to the Purchasing Power Parity, and the Interest Rate Differential SP - 4504 VL - 10 IS - 23 DO - 10.3390/math10234504 UR - https://hdl.handle.net/21.15107/rcub_dais_14044 ER -
@article{ author = "Frömmel, Michael and Vukovic, Darko B. and Wu, Jinyuan", year = "2022", abstract = "This study applies a Markov switching error correction model to describe the single most important real exchange rate (Deutsche mark versus US dollar) over the flexible exchange rates period from 1973 to 2004. We show an alternative way of modelling non-linear adjustment to the purchasing power parity (PPP) besides standard threshold models. The model merges the two possible sources of non-linearity by additionally allowing the probability of a mean-reverting regime to increase with the distance from PPP. The interest rate differential as an additional determinant of real exchange rate behaviour in a Markov switching framework is introduced in the model. The study finds that the real dollar exchange rate during the post-Bretton Woods era is well described by a Markov switching error correction model with (PPP) as long-run equilibrium. There is one mean reversion regime where PPP and the interest parity condition are valid. Contrary, the second regime is characterised by persistent mean aversion, where a regime switch does not become more likely with increasing distance from PPP. The unconditional half-life of shocks is about 1.5 years.", publisher = "MDPI AG", journal = "Mathematics", title = "The Dollar Exchange Rate, Adjustment to the Purchasing Power Parity, and the Interest Rate Differential", pages = "4504", volume = "10", number = "23", doi = "10.3390/math10234504", url = "https://hdl.handle.net/21.15107/rcub_dais_14044" }
Frömmel, M., Vukovic, D. B.,& Wu, J.. (2022). The Dollar Exchange Rate, Adjustment to the Purchasing Power Parity, and the Interest Rate Differential. in Mathematics MDPI AG., 10(23), 4504. https://doi.org/10.3390/math10234504 https://hdl.handle.net/21.15107/rcub_dais_14044
Frömmel M, Vukovic DB, Wu J. The Dollar Exchange Rate, Adjustment to the Purchasing Power Parity, and the Interest Rate Differential. in Mathematics. 2022;10(23):4504. doi:10.3390/math10234504 https://hdl.handle.net/21.15107/rcub_dais_14044 .
Frömmel, Michael, Vukovic, Darko B., Wu, Jinyuan, "The Dollar Exchange Rate, Adjustment to the Purchasing Power Parity, and the Interest Rate Differential" in Mathematics, 10, no. 23 (2022):4504, https://doi.org/10.3390/math10234504 ., https://hdl.handle.net/21.15107/rcub_dais_14044 .