Time-Varying Thresholds: An Application to Purchasing Power Parity

The confusing time-series behaviour of real exchange rates: Are asymmetries important?

“…Rationales appear to point to on the one hand central bank action to defend excessive depreciations (notably Almekinders and Eijffinger, 1996 argue that the US Fed has acted in this manner), while on the other hand Leon and Najarian (2003) find the response to over-appreciations may be stronger (duration of deviations shorter) for G7 markets, perhaps due to the negative terms of trade effects, moreover, over-appreciations are related to trade openness. Finally, given these response behaviours as well as the prominence of the US dollar, market participants may be more willing to tolerate US dollar over-appreciations from equilibrium than over-depreciations.…”

“…8 This is consistent with the larger 1 , where from a US perspective depreciating deviations are corrected quicker. Furthermore, Leon and Najarian (2003) argued that over-appreciations and depreciations respond to different factors. In particular, they report that over-appreciations are related to trade-openness as suggested by PPP theory, where misalignments are corrected by trade, but that over-depreciations are related to debt ratios, and in particular its implications for the costs of external debt.…”

Asymmetric adjustment and nonlinear dynamics in real exchange rates

“…Asymmetry also holds on a cross-section basis. Using the results from identical TAR models for an expanded set of 35 countries, for which both debt and openness data were available, Leon and Najarian (2003) found a positive correlation between average openness 29 and average duration for over-appreciations but no correlation between average openness and average duration for overdepreciations; similarly, they found a positive correlation between the average debt-to-GDP ratio and the average excess deviation (as defined in this paper) for over-depreciations but no correlation between the debt-to-GDP ratio and the excess deviation for over-appreciations. The implication that openness may be related to duration of over-appreciation misalignments but debt ratios are related to excess deviations of over-depreciations merits further research.…”

“…This implies that within the band, deviations from PPP may exhibit unit root behaviour, but the adjustment process is reverting or stationary in the outer bands. Because the bands of inaction may vary over time, due to changes in relative transactions costs, other market frictions and/or policy intervention, Leon and Najarian (2003) introduce and estimate the following time-varying TAR (TVTAR): …”