Nonlinear mean reversion in real exchange rates

Abstract This paper modifies a unit-root test procedure in the nonlinear STAR framework recently advanced by Kapetanios et al. [Journal of Econometrics (2001) in press]. Using a detrending methodology suggested by Schmidt and Phillips [Oxford Bulletin of Economics and Statistics 54 (1992) 257], we derive an alternative unit-root test and apply it to the bilateral real exchange rates for the G7 countries. We find that the use of our test is able to uncover evidence of nonlinear mean-reversion for most cases whereas the standard Dickey–Fuller test based on the linear model cannot.

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