Abstract
The empirical findings supporting the theory of the Purchasing Power Parity (PPP) for the developed and developing countries remain a controversial issue as the empirical evidence is still inconclusive. Indeed, the nature of the deviation dynamics from PPP has strongly challenged the PPP theory and deepened the Rogoff puzzle (Journal of Economic literature XXXIV: 647–668, 1996). This paper contributes to empirical research [Baum et al. (Journal of International Money and Finance 20: 379–399, 2001); Taylor et al. (International Economic review 42(4): 1015–1042, 2001), Michael et al. (Journal of Political Economy 105: 862–879, 1997)] by testing the stationarity of the bilateral real exchange rate of the dollar vis-à-vis the currencies of the MENA countries in a nonlinear framework consistent with the presence of transaction costs and tariff and nontariff barriers in international trade. The use of Teräsvirta’s procedure shows that the logistic or exponential smooth transition autoregressive models correctly generate 10 out of 13 real exchange rates of the countries under consideration. The estimation of these statistical models shows nonlinear and globally mean-reverting processes of the real exchange rates in several of these countries but a significant persistence of the exchange rate dynamics in few of them. The estimated transition functions consolidate the nonlinearity of the deviations from the PPP proving that the LSTAR and ESTAR processes are appropriate to analyse the adjustment of the real exchange rates to the PPP.
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Notes
- 1.
The PPP theory states that national price levels expressed in a common currency should be equal. The underlying intuition is the law of one price according to which international arbitrage equalizes prices across countries. Thus, according to this theory the nominal exchange rate between two currencies of any two economies should adjust to reflect differences in the relative price levels in these economies. This can be expressed by the following equation: P = SP* where P expresses the domestic currency price of the good, S is the nominal exchange rate at the home currency price of foreign currency and P* is the foreign consumer price (Hachicha 2008).
- 2.
This reasoning is both acceptable by traditional international macroeconomic analysis (e.g. Dornbusch 1976) and by the new open economy macroeconomics based on intertemporal optimizing models.
- 3.
The first puzzle is the non-stationarity of the deviations from PPP while the second puzzle consists in the high degree of persistence in real exchange rate deviations.
- 4.
It is worth highlighting some striking features of the economies of the MENA countries included in our study. Firstly, in most of these countries, export and the real exchange rate policy constitute a key factor of their growth and secondly, the crude oil product and export are the principal source of their foreign exchange reserves.
- 5.
Such a test allows the presence of a ‘corridor regime’ within which mean reversion does not take place, a characteristic consistent with the recent theoretical models where the presence of nonlinearities implies a ‘band of inaction’.
- 6.
- 7.
Deviations from the PPP are not corrected if they are small relative to the costs of trading. This means that proportional or ‘iceberg’ costs create a band (threshold) for real exchange rate, in which the marginal cost of arbitrage is higher than the marginal benefits and the adjustment process to the PPP does not take place.
- 8.
Cited by Paya and Peel (2004: p. 302), ‘in aggregate data, regime changes may be smooth rather than discrete given that heterogeneous agents do not act simultaneously even if they make dichotomous decisions’.
- 9.
Following the standard literature, the transition function F(.) is supposed to be a logistic function: F(q t − d , γ, μ) = (1 + exp(−γ(q t − d − μ)))− 1 or an exponential function F(q t − d , γ, μ) = 1 − exp(−γ(q t − d − μ)2). The ESTAR model was introduced to econometric literature by Granger and Teräsvirta (1993) and Teräsvirta (1994). A survey of recent developments in ESTAR modelling is given by van Dijk et al. (2002).
- 10.
In the outer regimes (F (γ, μ, q t − d ) ≈ 1), Eq. (2) can be rewritten as follows: \( \kern0.24em \varDelta {q}_t={\tilde{\theta}}_0+\tilde{\theta}{q}_{t-1}+\sum_{i=1}^{p-1}{\tilde{\delta}}_i\varDelta {q}_{t- i}+{\varepsilon}_t.\kern0.36em \) A mean-reverting process of real exchange rates in these regimes requires that \( \tilde{\theta}\prec 0\kern0.24em \) or θ 1 + θ 2 ≺ 0.
- 11.
The null hypothesis of this test postulates that the time series under investigation is generated by an autoregressive linear process while the alternative hypothesis supposes that the time series is characterized by a non linear process, namely the smooth transition autoregressive (STAR) process.
- 12.
In small samples, van Dijk (1999) recommends to use the F-version of the LM-test statistics because it has better size and power properties than the χ 2variants.
- 13.
The number of MENA region is 23. Due to data constraints, our sample is constituted by the following countries: Algeria, Bahrain, Egypt, Kuwait, Jordan, Qatar, Iran, Libya, Malta, Morocco, Saudi Arabia, Syria and Tunisia.
- 14.
According to Taylor and Peel (2000, p. 43), the ‘test for the transition parameters to be significantly different from zero effectively test the null hypothesis of a unit root against the alternative hypothesis of nonlinear mean reversion and in that sense, is ‘nonlinear augmented Dickey-Fuller test”.
- 15.
The dynamics of real exchange rates of the MENA region countries are in line with their macroeconomic policy. In the case of extrovert countries (Morocco and Egypt), we notice an over-evaluation of their real currencies which is not the case for Libya, Iran, Saudi Arabia, Kuwait and Qatar.
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Hachicha, N., Frikha, W. (2014). Transaction Costs and Nonlinear Modelling of Real Exchange Rate Deviations from Purchasing Power Parity: Evidence from the MENA Region. In: Dufrénot, G., Jawadi, F., Louhichi, W. (eds) Market Microstructure and Nonlinear Dynamics. Springer, Cham. https://doi.org/10.1007/978-3-319-05212-0_11
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