Equilibrium exchange rate determination and multiple structural changes

The large appreciation and depreciation of the US dollar in the 1980s stimulated an important debate on the usefulness of unit root tests in the presence of structural breaks. In this paper, we propose a simple model to describe the evolution of the real exchange rate. We then propose a more general smooth transition (STR) function than has hitherto been employed, which is able to capture structural changes along the (long-run) equilibrium path, and show that this is consistent with our economic model. Our framework allows for a gradual adjustment between regimes and allows for under- and/or over-valued exchange rate adjustments. Using monthly and quarterly data for up to twenty OECD countries, we apply our methodology to investigate the univariate time series properties of CPI-based real exchange rates with both the U.S. dollar and German mark as the numeraire currencies. The empirical results show that, for more than half of the quarterly series, the evidence in favour of the stationarity of the real exchange rate was clearer in the sub-sample period post-1980.Unit root tests, structural breaks, purchasing power parity

3-Regime symmetric STAR modeling and exchange rate reversion

The breakdown of the Bretton Woods system and the adoption of generalised floating exchange rates ushered in a new era of exchange rate volatility and uncer­tainty. This increased volatility lead economists to search for economic models able to describe observed exchange rate behavior. In the present paper we propose more general STAR transition functions which encompass both threshold nonlinearity and asymmetric effects. Our framework allows for a gradual adjustment from one regime to another, and considers threshold effects by encompassing other existing models, such as TAR models. We apply our methodology to three different exchange rate data-sets, one for developing countries, and official nominal exchange rates, and the second for emerging market economies using black market exchange rates and the third for OECD economies.unit root tests, threshold autoregressive models, purchasing power parity.

Nominal interest rates and stationarity

This paper investigates the (break) stationarity null hypothesis using data for 25 interest rates with different maturities and risk characteristics in Canada and the US. In contrast to a large part of the literature, this paper reports strong empirical evidence in favour of the null hypothesis of stationarity for the interest rate series.

Technical Appendix-3-Regime asymmetric STAR modeling and exchange rate reversion

The breakdown of the Bretton Woods system and the adoption of generalized oating exchange rates ushered in a new era of exchange rate volatility and uncer- tainty. This increased volatility lead economists to search for economic models able to describe observed exchange rate behavior. The present is a technical Appendix to Cerrato et al. (2009) and presents detailed simulations of the proposed methodology and additional empirical results.unit root tests, threshold autoregressive models, purchasing power parity.

Microstructure order flow: statistical and economic evaluation of nonlinear forecasts

In this paper we propose a novel empirical extension of the standard market microstructure order flow model. The main idea is that heterogeneity of beliefs in the foreign exchange market can cause model instability and such instability has not been fully accounted for in the existing empirical literature. We investigate this issue using two different data sets and focusing on out- of-sample forecasts. Forecasting power is measured using standard statistical tests and, additionally, using an alternative approach based on measuring the economic value of forecasts after building a portfolio of assets. We …nd there is a substantial economic value on conditioning on the proposed models.microstructure, order flow, forecasting

Open issues in financial economics

The breakdown of the Bretton Woods system and the adoption of generalized floating exchange rates ushered in a new era of exchange rate volatility and uncertainty. This increased volatility led economists to search for economic models able to describe observed exchange rate behaviour. In chapter 2 we propose more general STAR transition functions which encompass both threshold non-linearity and asymmetric effects. Our framework allows for a gradual adjustment from one regime to another, and considers threshold effects by encompassing other existing models, such as TAR models. We apply our methodology to three different exchange rate data-sets, one for developing countries, and official nominal exchange rates, the second emerging market economies using black market exchange rates and the third for OECD economies. The large appreciation and depreciation of the dollar in the 1980s stimulate an exciting academic debate on using unit root tests for structural break. We propose a model which is the natural extension of the behavioural equilibrium exchange rate (BEER) model. We then propose more general smooth transition (STR) functions, which are able to capture structural changes along the equilibrium path, and are consistent with our economic model. Our framework allows for a gradual adjustment between regimes and considers under- and/or over-valued exchange rate adjustment. We apply our methodology to the monthly and quarterly nominal exchange rates for seventeen and twenty OECD economies and construct bilateral CPI-based real exchange rates against the U.S. dollar and the German mark. The investigation of chapter 4 focuses on non-linear forecasts to testing exchange rate models by examining microstructure - order flow. The basic hypothesis is that if order flow includes heterogeneous beliefs and the information contained in them, heterogenous customer order flow can have forecasting power for exchange rates. Using statistical and economic evaluation, we quantify the role that, when the information is lagged or simultaneously released to all market participants, the key micro level price determinants - order flows is impounded into price. The results indicate: 1) order flow with non-linear consideration lead to considerable and statistically significant improvements compared to the random walk model; and 2) order flow is a powerful predictor of the exchange rate movement in an out-of-sample exercise, on the basis of economic value criteria such as Sharpe ratio and performance fees implied by utility calculations

3-Regime asymmetric STAR modeling and exchange rate reversion

The breakdown of the Bretton Woods system and the adoption of generalized ‡oating exchange rates ushered in a new era of exchange rate volatility and uncertainty. This increased volatility lead economists to search for economic models able to describe observed exchange rate behavior. In the present paper we propose more general STAR transition functions which encompass both threshold nonlinearity and asymmetric e¤ects. Our framework allows for a gradual adjustment from one regime to another, and considers threshold e¤ects by encompassing other existing models, such as TAR models. We apply our methodology to three di¤erent exchange rate data-sets, one for developing countries, and o ¢ cial nominal exchange rates, the second emerging market economies using black market exchange rates and the third for OECD economies

Equilibrium exchange rate determination and multiple structural changes

The large appreciation and depreciation of the US Dollar in the 1980s stimulated an important debate on the usefulness of unit root tests in the presence of structural breaks. In this paper, we propose a simple model to describe the evolution of the real exchange rate. We then propose a more general smooth transition (STR) function than has hitherto been employed, which is able to capture structural changes along the (long-run) equilibrium path, and show that this is consistent with our economic model. Our framework allows for a gradual adjustment between regimes and allows for under- and/or over-valued exchange rate adjustments. Using monthly and quarterly data for up to twenty OECD countries, we apply our methodology to investigate the univariate time series properties of CPI-based real exchange rates with both the U.S. Dollar and German Mark as the numeraire currencies. The empirical results show that, for more than half of the quarterly series, the evidence in favor of the stationarity of the real exchange rate was clearer in the sub-sample period post-1980