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Mean-reversion vs. adjustment to PPP: the two regimes of exchange rate dynamics under the EMS, 1979–1998

Bessec, Marie (2003), Mean-reversion vs. adjustment to PPP: the two regimes of exchange rate dynamics under the EMS, 1979–1998, Economic Modelling, 20, 1, p. 141–164. http/dx.doi.org/10.1016/S0264-9993(01)00089-X

Type
Article accepté pour publication ou publié
Date
2003-01
Journal name
Economic Modelling
Volume
20
Number
1
Publisher
Elsevier
Pages
141–164
Publication identifier
http/dx.doi.org/10.1016/S0264-9993(01)00089-X
Metadata
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Author(s)
Bessec, Marie
Abstract (EN)
This paper examines jointly the empirical relevance of the mean-reversion and the PPP hypotheses in the exchange rate dynamics under the EMS. Given the non-stationarity and the non-linearities characterizing the foreign exchange rate dynamics, this question is studied using a MS-ECM model: it allows a discontinuous adjustment towards the cointegration relationship. We find that the European exchange rates of the ERM members display mean-reversion towards the central parity in the credible regime, whereas they adjust to the PPP during the volatile period. The first mechanism is due to the stabilizing effect of a credible target-zone, while the second one can be explained by the realignments made in accordance with the underlying inflation rates.
Subjects / Keywords
Exchange rates; European Monetary System; Markov-switching; Error correction models
JEL
F31 - Foreign Exchange
F33 - International Monetary Arrangements and Institutions
C32 - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models

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