Threshold Cointegration and the PPP Hypothesis

Abstract

Self-Exciting Threshold Autoregressive (SETAR) models are a non-linear variant of conventional linear Autoregressive (AR) models. One advantage of SETAR models over conventional AR models lies in its flexible nature in dealing with possible asymmetric behaviour of economic variables. The concept of threshold cointegration implies that the Error Correction Mechanism (ECM) at a particular interval is inactive as a result of adjustment costs, and active when deviations from equilibrium exceed certain thresholds. For instance, the presence of adjustment costs can, in many circumstances, justify the fact that economic agents intervene to recalibrate back to a tolerable limit, as in the case when the benefits of adjustment are superior to its costs. We introduce an approach that accounts for potential asymmetry and we investigate the presence of the relative version of the purchasing power parity (PPP) hypothesis for 14 countries. Based on a threshold cointegration adaptation of the unit root test procedure suggested by Caner & Hansen (2001), we find evidence of an asymmetric adjustment for the relative version of PPP for eight pairs of countries.Nonlinearity, cointegration, Setar models,

Determination of the international maize price: What is the growing role of Brazil and Ukraine?

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Impacts of the End of the Coffee Export Quota System on International‐to‐Retail Price Transmission

“…The parameter d represents the delay in the change from one regime to the other (e.g. d = 1 indicates a change on an immediate occurrence) and is typically determined through statistical testing (Goodwin and Holt, 1999; Gouveia and Rodrigues, 2004).…”

An empirical study on the threshold cointegration of Chinese A and H cross-listed shares

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