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Smooth transition models and arbitrage consistency

Peel, D and Venetis, I A (2005) Smooth transition models and arbitrage consistency. Working Paper. The Department of Economics, Lancaster University.

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Abstract

Slow adjustment of real exchange rate towards its long run equilibrium in linear models has long puzzled researchers and provided the impetus for the adoption of particular classes of nonlinear models. The exponential smooth transition model has been particularly successful as an ex post characterization of time series purchasing power parity data providing faster adjustment speeds. In this paper we discuss some of its theoretical limitations as an ex ante data generating mechanism since one interpretation of it is that expectations are adaptive. We propose a new nonlinear model which is conceptually superior to the ESTAR model since it is consistent with rational expectations. One of the advantages of the model is that it can be solved and estimated by nonlinear least squares. Using monthly post-1973 real exchange rate data, we show that the model implies even faster speeds of adjustment.

Item Type: Monograph (Working Paper)
Uncontrolled Keywords: Mean reversion ; ESTAR ; real exchange rate ; purchasing power parity
Subjects: H Social Sciences > HB Economic Theory
Departments: Lancaster University Management School > Economics
ID Code: 48776
Deposited By: ep_importer_pure
Deposited On: 11 Jul 2011 22:11
Refereed?: No
Published?: Published
Last Modified: 27 Jul 2012 01:14
Identification Number:
URI: http://eprints.lancs.ac.uk/id/eprint/48776

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