mean reversion in real exchange rates evidence and implications for forecasting abstract the stationarity of real exchange rates over the recent flexible exchange rate period is an issue that has long bedeviled researchers in international finance using a constrained multivariate framework this paper provides the strongest evidence yet that real exchange rates were mean reverting over the 1973 93 period we also investigate shifts in long run real exchange rates which may be important for the purpose of forecasting out of sample forecasting shows that the random walk model is outperformed by a mean stationary model especially at long horizons in addition there are substantial forecasting benefits from using a multivariate approach

the european union currencies and the us dollar from post bretton woods to the euro abstract in this paper we study the evolution of the us dollar real exchange rate vis a vis the european union currencies in the floating post bretton woods era both before and after the birth of the euro in the first period we find that most of the persistence shown by this rate is due to the movements of the us dollar during the mid 1980s once these effects are isolated we can conclude that the us dollar real exchange rate exhibits stationarity with those currencies that are closely linked to the german mark however when we include the observations covering the period during which the euro was created we cannot reject the unit root null hypothesis for any currency

structural break nonlinearity and asymmetry a re examination of ppp proposition in this study we examine the validity of the ppp proposition for 28 european countries for this purpose we propose a new unit root test procedure that allows for both gradual structural breaks a

purchasing power parity in the long run a cointegration approach this paper utilizes cointegration analysis to examine purchasing power parity relationships over a long time horizon the results indicate that the exchange rate is cointegrated strongly with the wholesale price index ratio and somewhat weakly with the consumer price index ratio the cointegrating coefficient between the exchange rate and the price ratio is close to one when cointegration is confirmed the hypothesis that the real exchange rate follows a random walk is rejected in most cases finally a new test for common trends finds no such common trends in exchange rates or price ratios copyright 1990 by ohio state university press

deviations from purchasing power parity in the long run this paper demonstrates that deviations from purchasing power parity reveal a remarkable and possibly startling consistency with martingale behavior during both fixed and flexible rate periods for a wide variety of countries and in both monthly and annual data since this pattern appears to be much more general than one would expect on the basis of models founded on international commodity arbitrage the paper proposes an alternative explanation which instead relies on financial arbitrage in bonds as the underlying mechanism this paper will demonstrate that deviations from purchasing power parity ppp reveal a remarkable and possibly startling consistency with martingale behavior during both fixed and flexible exchange rate periods for a wide variety of countries and in both monthly and annual data this pattern appears to be much more general than one would expect on the basis of models founded on international commodity arbitrage the paper therefore proposes an alternative explanation which does not presuppose free trade in goods but which instead relies on financial arbitrage in bonds as the underlying mechanism the major implication of the theory and the results is that ppp is as likely to be violated in the long as in the short run as an empirical matter deviations from ppp can be observed for most currencies at any instant see kravis et al 21 stockman 37 and genberg 15 among others these deviations are typically both cumulative and persistent the real exchange rate can remain on either side of parity for lengthy but variable time intervals of a year or more as a consequence the current consensus shared

the great appreciation the great depreciation and the purchasing power parity hypothesis abstract although there has been much recent work on purchasing power parity ppp neither univariate nor panel methods have produced strong rejections of unit roots in us dollar real exchange rates for industrialized countries during the post 1973 period we investigate the hypothesis that these non rejections can be explained by one episode the large appreciation and depreciation of the dollar in the 1980s by developing unit root tests which account for this event and maintain long run ppp using panel methods we can strongly reject the unit root null for those countries that adhere to the typical pattern of the dollar s rise and fall

price level convergence and regional phillips curves in the us and emu abstract we use panel estimates of regional phillips curves of the hybrid new keynesian type to study price level convergence within the us and emu regional inflation rates tend to eliminate ppp deviations in both monetary unions with average half lives around 3 years the start of emu did not greatly affect ppp reversion in the euro area where changes in nominal exchange rates accounted for the bulk of the adjustment process before 1999 this role was largely taken over by regional inflation differences since notwithstanding clear evidence of forward lookingness in the us inflation persistence is substantial in both monetary unions

interest rates and currency prices in a two country world abstract this paper is a theoretical study of the determination of prices interest rates and currency exchange rates set in an infinitely lived two country world which is subject both to stochastic endowment shocks and to monetary instability formulas are obtained for pricing all equity claims nominally denominated bonds and currencies and these formulas are related to earlier closely related results in the theories of money finance international trade

property prices tax and expenditure levels and local fiscal performance where adjacent local governments provide different combinations of local expenditure and tax levels net differentials in the market value of these fiscal baskets will be capitalized into property values given sufficient data hedonic price estimation can attempt to estimate the degree of capitalization more importantly these results can provide an insight into local fiscal performance via residents evaluations both of the level of local taxes and expenditure and the way in which money is spent this methodology is developed and applied to greater manchester england employing a database of 5828 transactions in residential properties

the response of exchange rates to permanent and transitory shocks under floating exchange rates abstract using the joint behavior of inflation and real exchange rates we develop an empirical model to uncover the sources of the fluctuations in the real dollar exchange rates of four major industrial countries under the current float this model allows us to construct two time series for each country pair one representing the permanent component of each real exchange rate and the other the purely transitory component over the period as a whole transitory shocks played a relatively small but statistically significant role real dollar exchange rates therefore did not simply evolve in response to permanent shocks instead there are instances in which temporary shocks made a substantial contribution we conclude that the random walk model though an approximate statistical description of real exchange rate behavior is a poor guide to model structure jel f31

unit roots and purchasing power parity another kick at the can lopez et al 2005 demonstrated that single equation unit root tests cannot provide conclusive evidence of whether real exchange rates are stationary because inference depends critically on the lag lengths used to construct the test statistics a result reinforced by a recent work by sweeney 2006 the purpose of this article is to revisit the issue first demonstrating the necessary conditions under which this approach of testing for purchasing power parity ppp is appropriate

is purchasing power parity overvalued the purpose of this paper is to re examine the hypothesis of long run purchasing power parity among industrial countries under the current float using the panel data approach we propose a new finite sample panel data unit root test procedure that allows for a general serial correlation structure and arbitrary contemporaneous correlation in model innovations across countries this procedure is then applied to the recently developed panel data unit root tests of im pesaran and shin 1996 and of maddala and wu 1999 the test results show sufficient evidence against the unit root null for most samples by comparing our results with the existing ones in the literature we found that the method of assuming a restrictive serial correlation structure tends to weaken evidence against the unit root null

median unbiased estimation of structural change models an application to real exchange rate persistence measuring deviations from purchasing power parity has been the subject of extensive investigation the most common practice in empirical research for measuring real exchange rate persistence is to estimate univariate autoregressive ar time series models and calculate the half life defined as the number of periods for a unit shock to a time series to decay by 50 in the presence of structural change there are two potential biases in the parameter estimates of ar models 1 a downward small sample median bias and 2 an upward bias which occurs when structural change is present and ignored we conduct a variety of monte carlo simulations and demonstrate that the existence of structural change causes a substantial increase in the small sample bias documented in andrews 1993 we then propose an extension of median unbiased estimation which explicitly accounts for structural change and apply these methods to estimate half lives of several long horizon real exchange rates analysed by lothian and tayl

purchasing power parity and unit root tests using panel data abstract this paper reports the results of unit root tests for real exchange rates using a panel framework this panel approach provides greatly improved power compared to conventional univariate time series unit root tests we obtain evidence supporting ppp over the recent flexible exchange rate period for g 6 and oecd countries we show explicitly that failure to find such evidence in previous research was due to the low power of the tests

dynamic models for fixed income portfolio management under uncertainty abstract we develop multi period dynamic models for fixed income portfolio management under uncertainty using multi stage stochastic programming with recourse the models integrate the prescriptive stochastic programs with descriptive monte carlo simulation models of the term structure of interest rates extensive validation experiments are carried out to establish the effectiveness of the models in hedging against uncertainty and to assess their performance vis a vis single period models an application to tracking the salomon brothers mortgage index is reported with very encouraging results results that establish the efficacy of the models in hedging against out of sample scenarios are also reported for an application from money management the multi period models outperform classical models based on portfolio immunization and single period models

smooth breaks and non linear mean reversion post bretton woods real exchange rates the recent literature on purchasing power parity ppp has emphasized the role of two phenomena that may lead to the rejection of the ppp hypothesis structural breaks and non linear adjustment induced by transaction costs these two hypotheses are analyzed separately in the literature we develop tests for unit roots that account jointly for structural breaks and non linear adjustment structural breaks are modeled by means of a fourier function that allows for infrequent smooth temporary mean changes and is hence compatible with long run ppp nonlinear adjustment is modeled by means of an estar model our tests present good finite sample properties the tests are applied to a set of 15 oecd countries rers and are able to reject the null of a unit root in 14 cases the breaks are usually associated with the great appreciation and later depreciation of the dollar in the 1980s and the estar adjustment appears to play an important role

real exchange rate behavior abstract using random simulations with artificial data with identical sample characteristics to the long sample exchange rate data employed by lothian and taylor lothian j r and taylor m p 1996 the recent float from the perspective of the past two centuries journal of political economy 104 488 509 we show that standard unit root tests have extremely low power over sample sizes corresponding to the recent float the probability of rejecting the null hypothesis when it is false is extremely low with 20 years or even 50 years of data and only reaches an acceptable level over much longer spans

testing ppp hypothesis under temporary structural breaks and asymmetric dynamic adjustments we test the empirical validity of the ppp proposition under temporary structural breaks and dynamic nonlinear adjustments although several testing procedures have recently been proposed in the exi

are real exchange rates nonstationary evidence from a panel data test it is well documented that real exchange rates between the united states and many industrialized countries in the post bretton woods period are integrated this result implies that purchasing power parity ppp does not hold even as a long run relationship this paper demonstrates that the failure to reject the unit root hypothesis may result from the low power of existing univariate test procedures i test for unit roots in real exchange rates by employing a more powerful panel based procedure using both cpi and wpi real dollar exchange rate data i strongly reject the null hypothesis of a unit root my results provide overwhelming support for the long run ppp under the current float copyright 1996 by ohio state university press

real and nominal exchange rates in the long run an empirical investigation abstract this paper reports on econometric tests of the hypothesis that purchasing power parity holds as a long run relationship using data on eight industrialized countries during the flexible exchange rate period the empirical work proceeds by i testing whether nominal exchange rates and relative price levels are co integrated and ii conducting impulse response analysis of long run exchange rate and relative price level changes to explain the data keynesian models suggest that shocks during the estimation period were due principally to exogenous shifts in aggregate demand while equilibrium models suggest that monetary factors have been relatively more important

potential pitfalls in determining multiple structural changes with an application to purchasing power parity we investigate the empirical performance of the bai and perron multiple structural change tests and show that the use of their critical values may cause severe size distortions in persistent series to correct these size distortions while maintaining a good power we implement the bai structural change test and extend it in two directions developing a new procedure to choose the number of breaks and a restricted version that specifically models breaks that imply mean or trend reversion using our new methodologies we reconcile the results of unit root tests with those of tests for structural change when testing for long run purchasing power parity

real exchange rate adjustment in european transition countries abstract in single equation tests real exchange rates show mean reversion for nine of 10 central and eastern european transition countries for the period january 1993 to december 2005 because of the shift from controlled to market economies and accompanying crises failed policy regimes and changes in exchange rate regimes unit root tests for transition countries often require allowance for structural changes accounting for structural breaks gives substantially faster mean reversion speeds than those found for major industrialized countries these fast adjustment speeds are plausible transition countries had perhaps 10 years to make unprecedented adjustments required for accession to the european union a number of papers have applied non linear models to the central and eastern european countries this paper investigates four non linear models and compares them with piece wise linear break models the break models appear superior in detecting mean reversion for the central and eastern european transition countries

the purchasing power parity persistence paradigm abstract rogoff journal of economic literature 1996 34 647 668 describes the remarkable consensus of 3 5 year half lives of purchasing power parity deviations among studies using long horizon data these studies however focus on rejections of unit roots in real exchange rates and do not use appropriate techniques to measure persistence our half life estimates explicitly account for serial correlation sampling uncertainty and most importantly small sample bias calculating confidence intervals as well as point estimates for long horizon and post 1973 data we find that even though most of the point estimates lie within the 3 5 year range univariate methods provide virtually no information regarding the size of the half lives

long memory and nonlinear mean reversion in japanese yen based real exchange rates abstract the extraordinary difficulty in uncovering parity reversion in yen based real exchange rates has often been ascribed to a missing trend variable this study identifies an alternative explanation and shows that the puzzling behavior of real yen rates may stem from long memory dynamics which undermine unit root tests in their ability to detect mean reversion the long memory findings are consistent with the long swings in yen exchange rates during the current float further analysis also reveals evidence of non monotonic reversion toward parity

real exchange rate behavior the recent float from the perspective of the past two centuries using annual data spanning two centuries for dollar sterling and franc sterling real exchange rates we find strong evidence of mean reverting real exchange rate behavior using simple stationary autoregressive models estimated on prefloat data we easily outperform nonstationary real exchange rate models in dynamic forecasting exercises over the recent float such stationary univariate equations explain 60 80 percent of the in sample variation in real exchange rates although the degree of short run persistence may be high the econometric estimates imply a half life of shocks to the real exchange rate of about 6 years for dollar sterling and a little under 3 years for franc sterling

state of the art unit root tests and purchasing power parity although the question of whether purchasing power parity ppp holds in the long run has been extensively studied the answer is still controversial some of the strongest evidence is provided by taylor the review of economics and statistics 84 2002 139 150 who concludes that long run ppp held over the 20th century we argue that this conclusion is quite sensitive to the use of sub optimal lag selection in unit root tests using superior lag selection methods we find that long run ppp held for the real exchange rates of only 9 out of the 16 industrialized countries in taylor s sample with the u s dollar as the base currency

why panel tests of purchasing power parity should allow for heterogeneous mean reversion recent studies of purchasing power parity ppp use panel tests that fail to take into account heterogeneity in the speed of mean reversion across real exchange rates in contrast to several other severe restrictions of panel models and tests of ppp the assumption of homogeneous mean reversion is still widely used and its consequences are virtually unexplored this paper analyzes the properties of homogeneous and heterogeneous panel unit root testing methodologies using monte carlo simulation we uncover important adverse properties of the panel approach that relies on homogeneous estimation and testing more specifically power functions are low and assume irregular shapes furthermore homogeneous estimates of the mean reversion parameters exhibit potentially large biases these properties can lead to misleading inferences on the validity of ppp our findings highlight the importance of allowing for heterogeneous estimation when testing for a unit root in panels of real exchange rates

the choice of numeraire currency in panel tests of purchasing power parity we investigate the implications of the choice of numeraire currency on panel tests of purchasing power parity under the current regime of flexible exchange rates by conducting panel unit root tests with twenty one different base currencies we show that the conditions necessary for numeraire irrelevancy are not supported empirically and that the choice of numeraire currency can and does matter for ppp the evidence of ppp is stronger for european than for non european base currencies distance between the countries and volatility of the exchange rates are the most important determinants of the results

on cross country differences in the persistence of real exchange rates abstract previous findings of long run purchasing power parity come mainly from data for industrial countries raising the issue of whether the results suffer sample selection bias and exaggerate the general relevance of parity reversion this study uncovers substantial cross country heterogeneity in the persistence of deviations from parity the results show that it is more likely rather than less likely to find parity reversion for developing countries than industrial countries although some persistence variations may partly reflect country differences in structural characteristics such as inflation experience and government spending a considerable portion of those variations seems unaccounted for

nonlinearities in real exchange rate determination do african exchange rates follow a random walk in this article we aim at modelling the long run behaviour of the real effective exchange rates reer for a pool of african countries not much attention has been paid to this group of countries in particular to the existence of nonlinearities in the long run path of such a variable controlling for two sources of nonlinearities i e asymmetric adjustment to equilibrium and nonlinear deterministic trends allows us to gain some insight about the behaviour of the african reer we find that these sources of nonlinearities help us to explain the apparent unit root behaviour found applying linear unit root tests for most of the countries

changing monetary policy rules learning and real exchange rate dynamics when the exchange rate is priced by uncovered interest parity and central banks set nominal interest rates according to a reaction function such as the taylor rule the real exchange rate will be determined by expected inflation and the output gap or the unemployment gap of the home and foreign countries this paper examines the implications of these taylor rule fundamentals for real exchange rate determination because the true parameters in central bank policy rules are unknown to the public and change over time the model is presented in the context of a least squares learning environment this simple learning model captures the volatility and the major swings in the real deutschemark euro dollar exchange rate from 1976 to 2007

sharp breaks or smooth shifts an investigation of the evolution of primary commodity prices this paper explores the behavior of real commodity prices over a 50 year period attention is given to how the shifting means for various commodity prices have changed with a special emphasis on behavior since the mid 2000s to identify structural changes in commodity prices we estimate shifting mean autoregressions by using the bai and perron 1998 procedure for determining structural breaks low frequency fourier functions and a procedure that specifies shifts to be smooth logistic functions of time we find that the pattern in the timing of shifts is suggestive of the causal factors underlying the recent boom

does purchasing power parity hold sometimes regime switching in real exchange rates standard unit root tests are not very powerful in drawing conclusions regarding the validity of purchasing power parity ppp rather than asking whether ppp holds throughout the whole sample period we examine in this study if ppp holds sometimes by employing hamilton type 1989 markov regime switching models when at least one of multiple regimes is stationary ppp holds locally within the regime there are indeed various reasons that we should expect that the persistence of real exchange rates changes over time employing five real exchange rates spanning more than 100 years we find herein strong evidence that the strength of ppp varies during the sample periods and that there exist stationary regimes in which ppp holds throughout the article we also make comparisons to previous markov regime switching estimation results by kanas 2006 on the same data series the new markov switching model selection criterion of smith et al 2006 which is devised especially for discriminating markov regime s

increasing evidence of purchasing power parity over the current float we conduct unit root tests of real exchange rates with the united states dollar and the german mark as base currencies using samples of data which begin in 1973 and end between 1982 and 1996 we find that as the sample is extended the evidence of ppp strengthens with panel but not univariate methods because of the sharp rise and fall of the dollar in the early 1980s rejections of the unit root null do not monotonically increase with the sample size the evidence of ppp is uniformly stronger when the mark is used as the base currency

the ppp debate multiple breaks and cross sectional dependence abstract this study implements panel unit root ppp tests accommodating level and trend breaks and cross sectional dependence in the presence of breaks there is evidence of a currency and price index effect additionally accounting for cross sectional dependence overturns support for ppp

are bilateral real exchange rates stationary evidence from lagrange multiplier unit root tests for india the paper examines the stationarity of india s real exchange rate vis a vis 16 of its major trading partner countries for the period 1960 2000 application of the conventional adf unit root test the lagrange multiplier lm unit root test with one structural break and the lm unit root test with two structural breaks provides evidence that india s exchange rate vis a vis 15 out of 16 countries is stationary implying support for purchasing power parity

evidence on the purchasing power parity in a panel of cities evidence is provided on the ppp hypothesis using a sample of 50 spanish cities for a long time period through the application of panel data unit root tests although results suggest non rejection of the ppp short run deviations as measured by half lives indicate that real factors might be causing a slow rate of convergence to a common price index even in highly integrated economies

conditional ppp and real exchange rate convergence in the euro area abstract while economic theory highlights the usefulness of flexible exchange rates in promoting adjustment in international relative prices flexible exchange rates also can be a source of destabilizing shocks we find that when countries joining the euro currency union abandoned their national exchange rates the adjustment of real exchange rates toward their long run equilibrium surprisingly became faster to investigate we distinguish between differing rates of purchasing power parity ppp convergence conditional on alternative shocks which we refer to as conditional ppp we find that the loss of the exchange rate as an adjustment mechanism after the introduction of the euro was more than compensated by the elimination of the exchange rate as a source of shocks in combination with faster adjustment in national prices these findings support claims that flexible exchange rates are not necessary to promote long run international relative price adjustment

long run purchasing power parity in the 1920s abstract this paper presents an empirical analysis of long run purchasing power parity ppp during the 1920s float using recently developed methodology on the cointegration of economic time series our results are generally supportive of ppp as a long run equilibrium condition on which exchange rates tended to converge over the period for dollar sterling however there is some evidence of a non stationary drift away from fundamentals during the last year or so before britain s return to the gold standard perhaps due to speculation our results also appear to reconcile some apparently conflicting evidence in the literature

a model for designing callable bonds and its solution using tabu search abstract we formulate the problem of designing callable bonds as a non linear global optimization problem the data of the model are obtained from simulations of holding period returns of a given bond design which are used to compute a certainty equivalent return viz some target assets the design specifications of the callable bond are then adjusted so that the certainty equivalent return is maximized the resulting problem is multi modal and a tabu search procedure implemented on a distributed network of workstations is used to optimize the bond design the model is compared with the classical portfolio immunization model and the tabu search solution technique is compared with simulated annealing for solving the global optimization program it is shown that the global optimization model yields higher returns than portfolio immunization it is also shown that tabu search is computationally more efficient than simulated annealing in solving the model and it produces better solutions

cointegration how short is the long run abstract when testing for cointegration and faced with short sample periods it is common for researchers to turn to more frequently sampled observations that is to move from annual to quarterly or monthly data in order to increase the number of observations we argue that such a gain in the degrees of freedom is more apparent than real essentially cointegration is a long run concept and hence requires long spans of data to give tests for cointegration much power rather than merely large numbers of observations using monte carlo simulations we demonstrate this for four popular tests for cointegration

complete prepayment models for mortgage backed securities the estimation of prepayment rates for pools of mortgages is a critical component in determining the value of mortgage backed securities mbs for short and derivative products this paper discusses the development of prepayment models for pools of fixed rate mortgages the models are complete calibrated functional forms are given for all of the factors that determine prepayment rates hence the models can be used as benchmarks against the simple models of the public securities association the federal housing administration experience or the variety of projected prepayment rates generated by proprietary industry models the key factors that determine prepayment rates are 1 refinancing incentive 2 seasonal variations 3 seasoning of the mortgage pool and 4 burnout effect each factor is modeled separately and is calibrated using historical data a multiplicative relationship determines the prepayment rate of the mortgage pool a novel feature of our model is the use of basis functions that cap

commodity currencies and the real exchange rate abstract this paper examines whether the real exchange rates of commodity exporting countries and the real prices of their commodity exports move together over time using international monetary fund imf data on the world prices of 44 commodities and national commodity export shares we construct new monthly indices of national commodity export prices for 58 commodity exporting countries over 1980 2002 evidence of a long run relationship between national real exchange rate and real commodity prices is found for about one third of the commodity exporting countries the long run real exchange rate of these commodity currencies is not constant as would be implied by purchasing power parity based models but is time varying being dependent on movements in the real price of commodity exports

some new stylized facts of floating exchange rates abstract this paper re examines real exchange rate behavior of oecd currencies under the current float using the more extensive dataset that an additional decade s worth of experience has made available what emerges is a new set of stylized facts which suggest that the problems of the current float were not as commonly believed generic to that system but in fact rather specific being largely confined to one sub period the early and mid 1980s and one currency the us dollar this dollar behavior ranks as one of the important puzzles of the past 25 years

forecasting exchange rates out of sample with panel methods and real time data abstract this paper evaluates out of sample exchange rate forecasting with purchasing power parity ppp and taylor rule fundamentals for 9 oecd countries vis a vis the u s dollar over the period from 1973 q1 to 2009 q1 at short and long horizons in contrast with previous work which reports forecasts using revised data i construct a quarterly real time dataset that incorporates only the information available to market participants when the forecasts were made using bootstrapped out of sample test statistics the exchange rate model with taylor rule fundamentals performs better at the one quarter horizon and panel estimation is not able to improve its performance the ppp model however forecasts better at the 16 quarter horizon and its performance increases in panel framework the results are in accord with previous research on ppp and taylor rule models

the real exchange rate regime changes and volatility shifts we make use of a data set with both long span and high frequency to test for purchasing power parity ppp while allowing for a structural shift in the volatility of the mexico us bilateral real exchange rate rer the kim leybourne and newbold 2002 unit root test robust to changes in the innovation variance indicates mean stationarity of the monthly rer and hence evidence of ppp for the full sample 1930 2012 and various subsamples the persistence of deviations of the real rate from its ppp level as measured by half lives ranges from 1 37 to 2 41 years

do panels help solve the purchasing power parity puzzle although rogoff described the remarkable consensus of 3 to 5 year half lives of purchasing power parity ppp deviations among studies using long horizon data recent works using panel methods with post 1973 data report shorter half lives of 2 to 2 5 years but these studies do not use appropriate techniques to measure persistence we extend median unbiased estimation methods to the panel context calculate both point estimates and confidence intervals and provide strong evidence confirming rogoff s original claim although panel regressions provide more information on the persistence of real exchange rate shocks than univariate regressions they do not help solve the ppp puzzle

long run purchasing power parity redux abstract we test for long run covariability between nominal exchange rate depreciation and inflation differentials to provide a new perspective on long run purchasing power parity ppp the method directly tests cassel s concept of relative ppp and is more robust to departures from exact unit roots in nominal exchange rates or relative prices than standard unit root and cointegration tests for ppp the central result of the paper is that the 90 percent confidence interval for 1 the long run correlation coefficient is above zero and 2 the long run linear regression coefficient contains one and therefore long run ppp cannot be rejected for 9 of the 16 countries for six of the countries adding a third criterion that the confidence interval for the long run linear regression coefficient have relatively narrow bands provides strong evidence of long run ppp the evidence of long run ppp is much stronger for high inflation high depreciation countries than for low inflation low depreciation countries

a two factor stochastic programming model of danish mortgage backed securities abstract danish mortgage loans have several features that make them interesting short term revolving adjustable rate mortgages are available as well as fixed rate 10 20 or 30 year annuities that contain embedded options call and delivery options the decisions faced by a mortgagor are therefore non trivial both in terms of deciding on an initial mortgage and in terms of managing rebalancing it optimally we propose a two factor arbitrage free interest rate model calibrated to observable security prices and implement on top of it a multi stage stochastic optimization program with the purpose of optimally composing and managing a typical mortgage loan we model accurately both fixed and proportional transaction costs as well as tax effects risk attitudes are addressed through utility functions and through worst case min max optimization the model is solved in up to 9 stages having 19 683 scenarios numerical results which were obtained using standard soft and hardware indicate that the primary determinant in choosing between adjustable rate and fixed rate loans is the short long interest rate differential i e term structure steepness but volatility also matters refinancing activity is influenced by volatility and of course transaction costs

integrated simulation and optimization models for tracking indices of fixed income securities increasing performance pressures on fixed income managers have led to a search for new and creative ways to add to portfolio returns the largest pension plan sponsors insurance companies foundations and money management firms are using indexed portfolios as their fixed income assets management strategies since the late 1970s tracking a fixed income index is a difficult task due to transaction costs portfolio size and diversification restrictions liquidity requirements bid ask spreads etc this paper develops an integrated simulation and optimization approach for tracking fixed income indices the model was implemented at metropolitan life insurance company we introduce a simulation model for generating scenarios of holding period returns of the securities in the index then we develop optimization models to select a portfolio that tracks the index the models penalize downside deviations of the portfolio return from the index the developed framework is used to track the salomon brothers mortgag

real exchange rates under the gold standard purchasing power parity is one of the most important equilibrium conditions in international macroeconomics empirically it is also one of the most hotly contested numerous recent studies for example have sought to determine the validity of purchasing power parity using data from the post bretton woods float and have reached different conclusions we assert that most such studies are flawed for two reasons first the post 1973 data contain by definition only a very limited amount of the low frequency information relevant for examination of long run parity second the dynamic econometric techniques used to model deviations from parity are typically quite crude with respect to admissible low frequency dynamics both deficiencies are rectified in the present paper with dramatic results we construct a new data set of 16 real exchange rates covering more than a century of the classic gold standard period and we study deviations from parity using long memory models that allow for subtle forms of mean

panel stationarity tests for purchasing power parity with cross sectional dependence we investigate the purchasing power parity ppp hypothesis for a group of 17 countries using a new panel based test of stationarity that allows for arbitrary cross sectional dependence we treat the short run time series dynamics nonparametrically and thus avoid the need to fit separate and potentially misspecified models for the individual series the statistic is simple to compute and uses standard normal critical values even in the presence of a wide range of different deterministic components we also evaluate the behavior of the test using a factor model to approximate cross sectional dependence and find that it generally improves finite sample performance taken together these features provide a widely applicable solution to the problem of testing for stationarity versus unit roots in macro panel data the test finds significant evidence against the ppp null hypothesis being true even when allowance is made for structural breaks

a panel project on purchasing power parity mean reversion within and between countries abstract previous time series studies have shown evidence of mean reversion in real exchange rates deviations from purchasing power parity ppp appear to have half lives of approximately four years however the long samples required for statistical significance are unavailable for most currencies and are potentially inappropriate because of regime changes in this study we re examine deviations from ppp using a panel of 150 countries and 45 annual post wwii observations our panel shows strong evidence of mean reversion that is similar to that from long time series ppp deviations are eroded at a rate of approximately 15 annually i e their half life is around four years such findings can be masked in time series data but are relatively easy to find in cross sections

mussa redux and conditional ppp abstract the extreme persistence of real exchange rates found commonly in post bretton woods data does not hold in the preceding fixed exchange rate period when the half life was roughly half as large in our sample this finding supports sticky price models as an explanation for real exchange rate behavior extending the classic argument of mussa 1986 from a focus on short run volatility to long run dynamics two thirds of the rise in real exchange rate variance observed across exchange rate regimes is attributable to greater persistence of responses to shocks including greater price stickiness rather than to greater variance of shocks themselves

a stochastic programming model for money management abstract portfolio managers in the new fixed income securities have to cope with various forms of uncertainty in addition to the usual interest rate changes uncertainy in the timing and amount of cashflows changes in the default and other risk premia and so on complicate the portfolio manager s problem we develop here a multi period dynamic portfolio optimization model to address this problem the model specifies a sequence of investment decisions over time that maximize the expected utility of return at the end of the planning horizon the model is a two stage stochastic program with recourse the dynamics of interest rates cashflow uncertainty and liquidity default and other risk premia are explicitly modeled through postulated scenarios simulation procedures are developed to generate these scenarios the optimization models are then integrated with the simulation procedures extensive validation experiments are carried out to establish the effectiveness of the model in dealing with uncertainty in particular the model is compared against the popular portfolio immunization strategy and against a portfolio based on mean absolute deviation optimization

market frictions and real exchange rates abstract one explanation for the failure of purchasing power parity ppp is that market frictions impede trade allowing departures from ppp to grow quite large without precipitating goods arbitrage if this explanation is correct then other things equal large deviations from ppp should be less persistent than small differences this paper examines this prediction over the modern floating rate era the outcome is surprising between most countries large deviations from ppp appear to be at least as persistent as small deviations and perhaps even more so the exceptions are for some intra ec real exchange rates the implication is that market frictions alone do not explain the chimerical nature of ppp

u s dollar real exchange rates nonlinearity revisited abstract previous empirical work employing smooth transition autoregressive star models has found that u s dollar real exchange rates are nonlinear mean reverting processes we utilise tests developed from time varying smooth transition autoregressive tv star models to re examine dollar based rates these tests reveal that structural change is an important feature of the data in some cases there is support for both nonlinearity and structural change while in other cases there appears to be stronger support for structural change than for nonlinearity the results raise a number of interesting issues for future research

nominal exchange rate regimes and the real exchange rate abstract two assumptions about the real exchange rate are common in the literature on international finance 1 the real exchange rate is a random walk 2 the time series properties of the real exchange rate depend on the nominal exchange rate regime this paper presents evidence that indicates that the random walk behavior of the real exchange rate is only a characteristic of the post world war ii period moreover our findings also suggest that what is crucial to the real exchange rate behavior is the particular historical period rather than the nominal exchange rate arrangement

fiscal migration and the london boroughs an amended version of the aronson schwartz model and a more detailed econometric model are used to test the proposition that population movements within the london metropolitan area are related to the value for money provided by local authorities both approaches reveal evidence of a significant relationship which has a variety of implications for policy towards local government finance

evidence on purchasing power parity from univariate models the case of smooth transition trend stationarity recent research has found that trend break unit root tests derived from univariate linear models do not support the hypothesis of long run purchasing power parity ppp for us dollar real exchange rates in this paper univariate smooth transition models are utilized to develop unit root tests that allow under the alternative hypothesis for stationarity around a gradually changing deterministic trend function these tests reveal statistically significant evidence against the null hypothesis of a unit root for the real exchange rates of a number of countries against the us dollar however restrictions consistent with long run ppp are rejected for some of the countries for which a rejection of the unit root hypothesis is obtained

capital controls and the real exchange rate do controls promote disequilibria abstract the consensus view is that capital controls can effectively lengthen the maturity composition of capital inflows and increase the independence of monetary policy but are not generally effective at reducing net inflows and influencing the real exchange rate this paper studies the adjustment dynamics of the real exchange rate towards its long run equilibrium and presents empirical evidence that capital controls increase the persistence of misalignments allowing the speed of adjustment to vary according to the intensity of restrictions on capital flows it is shown that the real exchange rate converges to its long run level at significantly slower rates in countries with capital controls this result is stronger when the exchange rate is undervalued and is independent of confounding factors such as the exchange rate regime and other forms of heterogeneity affecting the speed of adjustment i also find evidence that controls on capital inflows have greater effects than controls on outflows in addition while the combination of capital controls with a fixed or managed exchange rate regime significantly increases the persistence of misalignments controls appear to loose traction under more flexible exchange rate arrangements

the panel purchasing power parity puzzle does long run purchasing power parity ppp hold over the post 1973 floating exchange rate period panel unit root tests provide evidence of ppp that increases with the number of observations the strengthening of the evidence however is highly cyclical when the dollar appreciates at the end of the sample the evidence of ppp strengthens and when it depreciates the evidence weakens while these patterns cannot be explained by the specifications that are normally used to model real exchange rates the strengthening but not the cyclical pattern can be explained by a specifi cation that incorporates ppp restricted structural change

governance infrastructure and us foreign direct investment this paper examines the statistical importance of governance infrastructure as a determinant of us foreign direct investment fdi in broad terms governance infrastructure represents attributes of legislation regulation and legal systems that condition freedom of transacting security of property rights and transparency of government and legal processes our econometric analysis uses a two stage estimation procedure in the first stage the probability that a country is an fdi recipient is estimated the results indicate that countries that fail to achieve a minimum threshold of effective governance are unlikely to receive any us fdi countries that receive no us fdi are typically countries that do not promote free and transparent markets that have ineffective governments and that often have legal systems that are not rooted in english common law in the second stage the analysis is restricted to those countries that did receive fdi flows the estimated equations focus on the determinants of the amount of fdi received given that a country is a recipient of us fdi governance infrastructure including the nature of the legal system is an important determinant of the amount received

restricted structural change and the unit root hypothesis i introduction an important issue in economics involves the long run response of macroeconomic and financial aggregates to shocks and disturbances in a classic paper nelson and plosser 1982 argued that contrary to the traditional view current shocks have permanent effects on the long run level of macroeconomic time series using statistical techniques developed by dickey and fuller 1979 they found evidence in favor of unit roots for 13 out of 14 long term annual macro series the only exception being the unemployment rate they conclude that these series behave more like a random walk than like transitory deviations from a steadily growing trend 1 nelson and plosser s findings of a unit root have been called into question on a number of grounds rudebusch 1992 1993 demonstrates that unit root tests have low power against estimated trend stationary alternatives moreover he shows that if trend stationary models are correct difference stationary models do not yield good approximations to the medium term dynamic response perron 1989 questions the ability of unit root tests to distinguish unit root from stationary processes that contain segmented or shifted trends incorporating an exogenous break point and specifying 1929 as the break date he found evidence of broken trend stationarity for 10 out of the 13 series perron s analysis was disputed by several papers most notably christiano 1992 banerjee lumsdaine and stock 1992 and zivot and andrews 1992 these authors argued that it is inappropriate to specify the break date as known as it is not reasonable to believe that the choice has been made independently of the data 2 they suggest that an appropriate procedure is to select the break date endogenously in particular zivot and andrews 1992 using a data dependent algorithm to determine the break point and finite sample critical values reject the unit root null at the 5 significance level for only 3 out of 13 nelson plosser series real gross national product gnp nominal gnp and industrial production 3 once this is done there is again little evidence against the unit root hypothesis allowing for two endogenous breaks lumsdaine and papell 1997 reexamined the unit root hypothesis for the nelson plosser data using finite sample critical values they rejected the unit root null for five series the three series found by zivot and andrews plus per capita real gnp and employment therefore finding more evidence against unit roots than zivot and andrews these studies reject the unit root hypothesis in favor of broken trend stationarity for macroeconomic aggregates but not for prices or financial variables this seems to confirm not only the common practice of macroeconomists to model movements in real gnp as stationary fluctuations around a linear deterministic trend blanchard 1981 kydland and prescott 1980 but also previous analyses which had advanced the unit root hypothesis for the velocity of money gould and nelson 1974 and stock prices samuelson 1973 results of the previous studies show that for many of the aggregate time series the estimated breaks coincide with world wars or the great depression standard macroeconomic theory however argues that while these events have long lasting transitory effects they do not have permanent effects on aggregate variables the decline in output associated with the great depression has generally been interpreted as a temporary response to a significant reduction in the money stock friedman and schwartz 1963 and the substantial increase in output that occurred during world war ii is described as the result of the huge temporary increase in government purchases caused by the war barro 1981 murray and nelson 2000 studying long term real gross domestic product gdp data argued that the fluctuations of 1930 1946 seem to have had a temporary effect on the level of output and lead to rejections of the unit root hypothesis when it is true

searching for stationarity purchasing power parity under the current float abstract using panel data methods we investigate long run purchasing power parity by testing for unit roots in real exchange rates of industrial countries under the current float the evidence against the unit root hypothesis is stronger for larger than for smaller panels for monthly than for quarterly data and when the german mark rather than the united states dollar is used as the base currency while we find that accounting for serial correlation considerably weakens the evidence against the unit root null the results as a whole are consistent with long run purchasing power parity

covariate selection for testing purchasing power parity this article employs hansen s 1995 covariate augmented dickey fuller cadf test to reexamine the issue of purchasing power parity ppp using post bretton woods exchange rate data for 20 industrialized countries instead of just using a single covariate as in the literature we implement the test by using bai and ng s 2002 method to choose suitable stationary covariates our empirical results show that the real exchange rates generally display long run mean reversion and support ppp as contrasted with those obtained in amara and papell 2006 that less rejections of unit root hypothesis are made with the same test the panel unit root test suggested by chang 2004 is also performed to justify our results

capturing the correlations of fixed income instruments this paper develops a framework for managing portfolios of fixed income instruments based on traditional principles from the equities market i e based on diversification it shows through an analysis of the high yield bond market over the period 1987 to 1991 that fixed income prices could be highly correlated these correlations can be quantified and integrated in a systematic way in an asset liability management framework for vanishing fixed income securities however we cannot resort to statistical analysis of historical data in order to quantify correlations the paper develops a forward looking simulation procedure for capturing correlations applications are illustrated for examples from high yield bonds and mortgage backed securities the superiority of the proposed approach over the traditional portfolio immunization techniques is demonstrated in the context of funding an insurance liability stream with mortgage instruments

unilateral divorce versus child custody and child support in the u s this paper explores the response of the divorce rate to law reforms introducing unilateral divorce after controlling for law reforms concerning the aftermath of divorce which are omitted from most previous studies we introduce two main policy changes that have swept the us since the late 1970s the approval of the joint custody regime and the child support enforcement program because those reforms affect divorce decisions by counteracting the reallocation of property rights generated by the unilateral divorce procedure and by increasing the expected financial costs of divorce it is arguable that their omissions might obscure the impact of unilateral divorce reforms on divorce rates after allowing for changes in laws concerning the aftermath of divorce we find that the positive impact of unilateral divorce reforms on divorce rates does not vanish over time suggesting that the coase theorem may not apply to changes in divorce laws supplemental analysis developed to examine the frequency of permanent shocks in us divorce rates indicates that the positive permanent changes in divorce rates can be associated with the implementation of unilateral divorce reforms and that the negative permanent changes can be related to the law reforms concerning living arrangements in the aftermath of divorce this seems to confirm the important role of these policies in the evolution of divorce rates

additional evidence of long run purchasing power parity with restricted structural change we investigate two alternative versions of purchasing power parity ppp reversion to a constant mean in the spirit of cassel and reversion to a constant trend in the spirit of balassa and samuelson using long span real exchange rate data for industrialized countries we develop unit root tests that both account for structural change and maintain a long run mean or trend with conventional tests previous research finds evidence of some variant of ppp for 9 of the 16 countries with the unit root tests in the presence of restricted structural change we find evidence of ppp for five additional countries

an empirical examination of long run purchasing power parity using cointegration techniques this paper presents an empirical analysis of long run purchasing power parity ppp for five major exchange rates using recently developed econometric techniques on the cointegration of economic time series our empirical results are extremely unfavourable to the ppp hypothesis as a long run equilibrium condition even with an allowance made for measurement error and or tranportation costs in particular we are unable to reject the hypothesis of non cointegration of the exchange rate and relative prices for any of the countries concerned far from finding a stable long run proportionality between exchange rates and relative prices our results therefore suggest that they tend to drift apart without bound

noise versus access the impact of an airport in an urban property market the effects of a major airport are unlikely to exhibit a uniform spatial distribution the benefits to industries and individual households may extend well beyond the local economy whereas many of the costs are spatially concentrated in the immediate environment in particular the problems of noise and traffic generation can be expected to fall principally upon adjacent populations this paper addresses the general question of whether the costs to local economies of airport proximity which are in the nature of externalities outweigh the benefits of access employment and improved infrastructure based on data relating to manchester airport and its surrounding areas the specific approach adopted in the paper involves an investigation of the extent to which such proximity effects are capitalised into residential property prices our results provide some evidence to suggest that circumstances may exist where positive attributes such as improved access and employment opportunities may be more highly va

capturing asymmetry in real exchange rate with quantile autoregression quantile autoregression qar is used to explore asymmetries in the adjustment process of pairwise real exchange rate rer between the italian lire french franc deutsch mark and the british pound based on the best specification for each quantile we construct predicted conditional density functions which guided us to identify two sources of asymmetry 1 dispersion depends on the conditioned value of the rer i e conditional heteroskedasticity 2 the probability of increases and falls also changes according to the conditioned value i e there is higher probability for the rer to appreciate depreciate given the currency is depreciated appreciated we only verified strong heterokedasticity in relations among the lire franc and mark which was resolved by estimating quadratic autoregressive model for some quantiles relations involving the pound presented stable but higher dispersion indicating larger probability of wider oscillation

the overvaluation of purchasing power parity abstract recent panel studies of purchasing power parity have reported strong evidence of mean reversion in real exchange rates however these studies fail to control for cross sectional dependence in the data this failure has dramatic consequences raising the significance level of tests with a nominal size of 5 percent to as much as 50 percent it is shown in this paper that controlling for cross sectional dependence no evidence against the random walk null can be found in panels of up to 64 real exchange rates this finding cannot be attributed to low power as there is ample power in panels of this size to reject the unit root null