Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/153116
Authors: 
Schnatz, Bernd
Year of Publication: 
2006
Series/Report no.: 
ECB Working Paper 682
Abstract: 
The paper tests for nonlinearities in the adjustment of the euro exchange rate towards purchasing power parity (PPP). It presents new survey based evidence consistent with non-linear patterns in euro exchange rate dynamics. Moreover, based on an exponential smooth transition autoregressive (ESTAR-) model, it finds strong evidence that the speed of mean reversion in euro exchange rates increases non-linearly with the magnitude of the PPP deviation. Accordingly, while the euro real exchange rate can be well approximated by a random walk if PPP deviations are small, in periods of significant deviations, gravitational forces are set to take root and bring the exchange rate back towards its long-term trend. Consistent with higher euro-dollar volatility, deviations from the PPP equilibrium for this pair need to be stronger in order to reach the same adjustment intensity as for other currencies.
Subjects: 
non-linearities
purchasing power parity
real exchange rate
STAR models
JEL: 
F31
Document Type: 
Working Paper

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