Abstract

This paper examines the mean-reverting property of real exchange rates. Earlier studies have generally not been able to reject the null hypothesis of a unit-root in real exchange rates, especially for the post-Bretton Woods floating period. The results imply that long-run purchasing power parity does not hold. More recent studies, especially those using panel unit-root tests, have found more favorable results, however. But, Karlsson and Löthgren (2000) and others have recently pointed out several potential pitfalls of panel unit-root tests. Thus, the panel unit-root test results are suggestive, but they are far from conclusive. Moreover, consistent individual country time series evidence that supports long-run purchasing power parity continues to be scarce. In this paper, we test for long memory using Lo's (1991) modified rescaled range test, and the rescaled variance test of Giraitis, Kokoszka, Leipus, and Teyssière (2003). Our testing procedure provides a non-parametric alternative to the parametric tests commonly used in this literature. Our data set consists of monthly observations from April 1973 to April 2001 of the G-7 countries in the OECD. Our two tests find conflicting results when we use U.S. dollar real exchange rates. However, when non-U.S. dollar real exchange rates are used, we find only two cases out of fifteen where the null hypothesis of an unit-root with short-term dependence can be rejected in favor of the alternative hypothesis of long-term dependence using the modified rescaled range test, and only one case when using the rescaled variance test. Our results therefore provide a contrast to the recent favorable panel unit-root test results.

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