Testing hypotheses in an model with piecewise linear trends. An analysis of the persistent long swings in the Dmk/$ rate

2014

Economics

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Researchers seldom find evidence of I(2) in exchange rates, prices, and other macroeconomics time series when they test the order of integration using univariate Dickey-Fuller tests. In contrast, when using the multivariate ML trace test they frequently find double unit roots in the data. The paper demonstrates by simulations that this often happens when the signal-tonoise ratio is small. JEL C1 C18 C22 C32 C52Keywords Univariate and multivariate unit root tests; double unit roots; near I(2)

Section: Introductionmentioning

confidence: 93%

Section: Multivariate I(2) Trace Testsmentioning

confidence: 99%

Section: Multivariate Var Based Unit Root Testsmentioning

confidence: 99%

Section: Testing the Order Of Integration Of Individual Variablesmentioning

confidence: 99%

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Testing for Near I(2) Trends When the Signal-to-Noise Ratio Is Small

2014

Economics

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“…In the foreign exchange market, the uncertainty premium is often measured by the PPP gap which has often been found to be near I(2) (Johansen et al (2010), Juselius and Assenmacher (2017)). Therefore, the change in the uncertainty premium, !…”

Section: Associating Expectations With Observables In An Imperfect Knmentioning

confidence: 99%

Using a Theory-Consistent CVAR Scenario to Test an Exchange Rate Model Based on Imperfect Knowledge

2017

SSRN Journal

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A theory-consistent CVAR scenario describes a set of testable regularieties one should expect to see in the data if the basic assumptions of the theoretical model are empirically valid. Using this method, the paper demonstrates that all basic assumptions about the shock structure and steady-state behavior of an an imperfect knowledge based model for exchange rate determination can be formulated as testable hypotheses on common stochastic trends and cointegration. This model obtained a remarkable support for almost every testable hypothesis and was able to adeqautely account for the long persistent swings in the real exchange rate.

Real exchange rate persistence and the excess return puzzle: The case of Switzerland versus the US

J of Applied Econometrics

Assenmacher

2017

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The PPP puzzle refers to the wide swings of nominal exchange rates around their long-run equilibrium values whereas the excess return puzzle represents the persistent deviation of the domestic-foreign interest rate differential from the expected change in the nominal exchange rate. Using the I(2) cointegrated VAR model, much of the excess return puzzle disappears when an uncertainty premium in the foreign exchange market, proxied by the persistent PPP gap, is introduced. Self-reinforcing feedback mechanisms seem to cause the persistence in the Swiss-US parity conditions. These results support imperfect knowledge based expectations rather than so-called "rational expectations". INTRODUCTIONIt is a well-established fact that the ratio of domestic to foreign goods prices typically changes only slowly while the nominal exchange rate undergoes large, persistent swings. As a result, both the real and the nominal exchange rate exhibit large swings away from and towards long-run benchmark values. These long swings around long-run fundamental values are hard to reconcile with standard monetary models based on Rational Expectations (RE) and a representative agent endowed with essentially perfect knowledge. 1 In the literature, alternative approaches that rely on heterogeneous agents and imperfect knowledge have been proposed. We call these "imperfect knowledge" based models in contrast to the conventional RE representative agent models. Common to these models is that today's asset price depends on future prices which, in varying degree, are forecast under imperfect knowledge and, thus, can deviate from the expected future prices as derived under RE. For example, Hommes (2005) and Hommes, Huang, and Wang (2005) and Hommes, Sonnemans, Tuinstra, and van de Velden (2005) developed models for a financial market populated by fundamentalists and chartists where fundamentalists use long-term expectations based on economic fundamentals and chartists are trend-followers using short-term expectations. 2 Positive feedback prevails when the latter dominate the market. In these models agents switch endogenously between a mean-reverting fundamentalist and a trend-following chartist strategy. The models were estimated by using a non-linear AR(1) model with a time-varying coefficient supposed to capture market sentiment. 3 By contrast, we shall use the I(2) CVAR model to capture the effect of dominant trend-followers formulated as error-increasing behavior away from long-run fundamental values (positive feedback) and the reversal to fundamental values as error-correcting behavior (negative feedback).Adam and Marcet (2011) proposed a separation of standard RE rationality into an internal and an external component. They showed that positive feedback can arise in a model where internal rationality is maintained but external rationality is relaxed due to imperfect market knowledge. Heemeijer, Hommes, Sonnemans, and Tuinstra (2009) used experiments and found that prices converge to their fundamental level under negative feedback but fail to d...