NON-LINEAR ADJUSTMENT PROCESS IN WON/DOLLAR AND WON/YEN REAL EXCHAGE RATES

Abstract

We examine the purchasing power parity (PPP) hypothesis in won/dollar and won/yen real exchange rates using a non-linear framework. Many empirical studies based on the linear framework have failed to find clear supporting evidence for the validity of PPP hypothesis. We test the PPP hypothesis using a two-stage procedure suggested by Engle and Granger (1987), and show that it fails to reject non-cointegration. Evaluating the linear model against the nonlinear STAR model, we find that linearity is clearly rejected, but ESTAR process is accepted. Moreover, the parameter estimates of the ESTAR model establish a certain pattern of random walk behavior for small deviations and of fast adjustment for large deviations, thus providing strong evidence for mean-reverting behavior in real won/dollar and won/yen exchange rates.Purchasing Power Parity, Non-linear Adjustment Process, ESTAR Model