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Economic Change and Restructuring

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01-08-2012

Nonlinear adjustment of Asian real exchange rates

Author: Salah A. Nusair

Published in: Economic Change and Restructuring | Issue 3/2012

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Abstract

We utilize nonlinear models to examine the stationarity of Asian real exchange rates over the period from 1980:10 to 2007:09, using the US, Japan, and China as base countries. We find evidence of nonlinearity in most cases. Contrary to widely-held belief that the behavior of the real exchange rate should exhibit symmetrical adjustment for deviations above and below the equilibrium level, we find strong evidence of asymmetrical adjustment for most cases. Applying unit root tests that account for two types of nonlinearities (smooth transition and nonlinear deterministic trends) reveals evidence of stationarity in all but the Philippines vis-à-vis Japan. Further testing shows that the results are robust to different exchange rate regimes and, in the case of Malaysia, robust to the imposition of capital controls after the 1997 Asian crisis.

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Long spans and panel data have also been used to increase the power of tests (see, for example, Taylor and Sarno 1998; Frankel and Rose 1996; Lothian and Taylor 1996; Abuaf and Jorion 1990). Although the two approaches have been more supportive of PPP, they have been subject to some criticism in the literature. Long-span studies have been criticized as they combine data from fixed and floating exchange rates regimes; hence, rejecting the null hypothesis does not provide direct evidence on the validity of PPP under the current float. The panel data approach has been criticized because it tests null hypothesis that all the series in the panel are nonstationary, in which case, the null would be rejected if there is only one series that is stationary (Taylor and Sarno 1998).

If the 10% significance level is used, the unit root null is rejected in all cases relative to China, except Indonesia and Japan. However, since the ADF test in known to lack power, the unit root null cannot be rejected unless there is strong evidence against it. Therefore, one should be cautious when using the 10 percent significance level.

To check the robustness of our results, we also applied Lee and Strazicich (2003, 2004) unit root tests that allow for one and two endogenously determined breaks. The results, not reported due to space limitation, are not significantly different from those obtained from Zivot-Andrews test. In particular, the test with a single break did not produce any evidence of stationarity in any case. However, the test with two breaks showed evidence of stationarity in only two cases; Indonesia relative to China, and Malaysia relative to the US. The results are not reported but available upon request from the author.

We also examined linearity over the range \( d \in \{ 1, \ldots , 36\} \). The null of linearity was decisively rejected in each case and regardless of the base country. The longest delay was 36 months observed for China and Singapore when the US was the base country and for Korea, Malaysia, Singapore, and Thailand when China was the base country. However, in modeling the behavior of the real exchange rate, small values of d are expected, since it represents the time before the real exchange rate begins to adjust in response to a shock. All unreported results are available upon request from the author.

The results with lags are not significantly different from those without lags.

Although the null of linearity could not be rejected for some countries over the range \( d \in \{ 1, \ldots , 12\} \), we tested the stationarity of the real exchange rates using the KSS test for all countries, because when linearity is tested over the range \( d \in \{ 1, \ldots , 36\} \) the null was decisively rejected in each case.

A number of studies testing the validity of PPP for Asian countries using the US and Japan as base countries have found that the evidence when Japan is the base country are rather scarce, see, for example, Nusair (2004) and Fujii (2002).

This has important implications on Fisher equation. Precisely, inflation targeting implies that Fisher relationship follows a nonlinear stochastic process that is mean reverting when inflation is outside the band and has a unit root inside the band (Nusair 2009).

I thank an anonymous referee for pointing out these issues.

These findings are in line with those of Baharumshah et al. (2010).

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Title: Nonlinear adjustment of Asian real exchange rates
Author: Salah A. Nusair
Publication date: 01-08-2012
Publisher: Springer US
Published in: Economic Change and Restructuring / Issue 3/2012
Print ISSN: 1573-9414
Electronic ISSN: 1574-0277
DOI: https://doi.org/10.1007/s10644-011-9116-x

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