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Adina Popescu

20 July 2009
A core stylized fact of the empirical exchange rate literature is that half-life deviations of equilibrium real exchange rates from levels implied by Purchasing Power Parity (PPP) are very persistent. Empirical efforts to explain this persistence typically proceed along two distinct paths, resorting either to the presence of real shocks such as productivity differentials that drive equilibrium exchange rates away from levels implied by PPP, or the presence of non-linearities in the adjustment process around PPP. By contrast, we combine these two explanations in the context of an innovative panel estimation methodology. We conclude that both explanations are relevant to the behavior of exchange rates and that resulting half-lives are much shorter than estimated using linear PPP and more consistent with the observed volatility of nominal and real exchange rates.
JEL Code
F31 : International Economics→International Finance→Foreign Exchange
C23 : Mathematical and Quantitative Methods→Single Equation Models, Single Variables→Panel Data Models, Spatio-temporal Models
L6 : Industrial Organization→Industry Studies: Manufacturing
L7 : Industrial Organization→Industry Studies: Primary Products and Construction
L8 : Industrial Organization→Industry Studies: Services
L9 : Industrial Organization→Industry Studies: Transportation and Utilities