Treshold effects in real interest rate parity for the Central and Eastern European countries

Treshold effects in real interest rate parity for the Central and Eastern European countries


Chi-Wei Su, Hsu-Ling Chang, Pei-Long Shen


Keywords: nonlinear threshold unit-root test, real interest rate parity


Summary: This study applies a nonlinear threshold unit-root test to assess the nonstationary properties of the real interest rate parity (RIRP) for twelve Central and Eastern European (CEE) countries. We find that the non-linear threshold unit-root test has a higher power than the linear method suggested by Caner and Hansen (2001) if the true data generating process of real interest rate convergence is in fact a stationary nonlinear process. We examine the validity of RIRP from the nonlinear point of view and provide robust evidence which clearly indicates that RIRP holds true for nine countries. Our findings point out that real interest rate convergence is mean reversion towards RIRP equilibrium values in a nonlinear way.



Arghyrou, M. G., Gregoriou, A., Kontonikas, A. Do Real Interest Rates Converge? Evidence from the European Union, “Journal of International Financial Markets”, 19, pp. 447-460, 2009.

Artis, M., Galvâo, A. B., Marcellino, M., The Transmission Mechanism in a Changing World, “Journal of Applied Econometrics”, 22, pp. 39-61, 2007.

Baum, C. F., Barkoulas, J. T., Caglayan, M., (2001) Nonlinear Adjustment to Purchasing Power Parity in the Post-Bretton Woods Era, “Journal of International Money and Finance”, 20, pp. 379-399. Camarero, M., Carrion-i-Silvestre, J. L., Tamarit, C., Testing for Real Interest Rate Parity Using Panel Stationarity Tests With Dependence: A Note, “The Manchester School”, 77, pp. 112-126, 2009.

Caner, M., Hansen, B., Threshold Autoregression With a Unit Root, “Econometrica”, 69, pp. 1555-1596, 2001.

Chen, S. W., Shen, C. H., A Sneeze in the US, a Cough in Japan, but Pneumonia in Taiwan? An  Application  of  the  Markov-Switching  Vector  Autoregressive  Model,  “Economic Modelling”, 48, pp. 1-48, 2007.

Chortareas, G. E., Kapetanios, G., Shin, Y., Nonlinear Mean Reversion in Real Exchange Rates, “Economics Letters”, 77, pp. 411-417, 2002.

Cuestas, J. C., Harrison, B., Further Evidence on the Real Interest Rate Parity Hypothesis in Central and Eastern European Countries: Unit Roots and Nonlinearities, “Emerging Markets Finance and Trade”, 46, pp. -39, 2010.

Cumby, R., Mishkin, F., The International Linkage of Real Interest Rates: The European-US Connection, “Journal of International Money and Finance”, 5, pp. 5-23, 1987.

Escribano, A.,Nonlinear Error Correction: The Case of Money Demand in the United Kingdom 1878-2000, “Macroeconomic Dynamics”, 8, pp. 76-116, 2004.

Ferreira,  A.  L.,  León-Ledesma,  M.  A.,  Does  the  Real  Interest  Parity  Hypothesis  Hold? Evidence for Developed and Emerging Markets, “Journal of International Money and Finance”, 26, pp. 364-382, 2007.

Fujii, E., Chinn, M. D., Fin de Siècle Real Interest Rate Parity, “NBER Working Paper” 7880, 2000.

Grubel, H. G. Internationally Diversified Portfolios: Welfare Gains and Capital Flows, “American Economic Review”, 58, pp. 1299-1314, 1968.

Haug, A. A., Tam, J.,A Closer Look at Long-Run U.S. Money Demand: Linear or Nonlinear Error-Correction With M0, M1, or M2?“Economic Inquiry”, 45, pp. 363-376, 2007.

Holmes, M. J., Wang, P.,Real Convergence and Regime-switching Among EU Accession Countries, “South-Eastern Europe Journal of Economics”, 1, pp. 9-27, 2008.

Kapetanios, G., Shin, Y., Snell, A., Testing for Cointegration in Nonlinear Smooth Transition Error Correction Models, “Econometric Theory”, 22, pp. 279-303, 2006.

Lütkepohl, H., Teräsvirta, T., Wolters, J., Investigating Stability and Linearity of a German M1 Money Demand Function,“Journal of Applied Econometrics”, 14, pp. 511-525, 1999.

Mark, N. C., Some Evidence on the International Equality of Real Interest Rates, “Journal of International Money and Finance”, 4, pp. 189-208, 1985.

Mark, N. C., Moh, Y. K., The Real Exchange Rate and Real Interest Differentials: The Role of Nonlinearities, “International Journal of Finance and Economics”, 10, pp. 323-335, 2005.

Michael, P., Nobay, A. R., Peel, D.,Transactions Costs and Nonlinear Adjustments in Real Exchange Rates: An Empirical Investigation, “Journal of Political Economy”, 105, pp. 862-879, 1997.

Mishkin, F., Are Real Interest Rates Equal Across Countries? An Empirical Investigation of International Parity Conditions, “Journal of Finance”, 39, pp. 1345-1357, 1984.

Peel, D. A., Venetis, I. A.,Smooth Transition Models and Arbitrage Consistency, “Economica”, 72, pp. 413-430, 2005.

Pipatchaipoom, O., Norrbin, S. C.,Is the Real Interest Rate Parity Condition Affected by the Method of Calculating Real Interest Rate?, “Applied Economics”, 42, pp. 1771-1782, 2010.

Rothman, P., van Dijk, D., Franses, P. H.,Multivariate Star Analysis of Money-Output Relationship, “Macroeconomic Dynamics”, 5, pp. 506-532, 2001.

Sarno, L., Taylor, M. P., Chowdhury, I.,Nonlinear Dynamics in Deviations from the Law of One Price: A Broad-based Empirical Study, “Journal of International Money and Finance”, 23, pp. 1-25, 2004.

Seo, M., Testing for Nonlinear Adjustment in Smooth Transition Vector Error Correction Models, Econometric Society, Far Eastern Meetings, 2004.

Seo, M.,Bootstrap Testing for the Null of No Cointegration in a Threshold Vector Error Correction Model, “Journal of Econometrics”, 143, pp. 129-150, 2006.

Singh, M., Banerjee, A.,Testing Real Interest Parity in Emerging Markets, IMF Working Paper WP/06/249, 2006.

Smith, P. A., Summers, P. M., How Well Do Markov Switching Models Describe Actual Business Cycles? The Case of Synchronization, “Journal of Applied Econometrics”, 20, pp. 253-274, 2005.

Sonora, R. J., Tica, J.,Real Interest Parity in New Europe, No 1011, EFZG Working Papers Series, Faculty of Economics and Business, University of Zagreb, 2010.

Taylor, M. P., Sarno, L., International Real Interest Rate Differentials, Purchasing Power Parity and the Behaviour of Real Exchange Rates: The Resolution of a Conundrum, “International Journal of Finance and Economics”, 9, pp. 15-23, 2004.

Teräsvirta, T., Eliasson, A. C., Nonlinear Error-correction and the UK Demand for Broad Money, 1878-1993, “Journal of Applied Econometrics”, 16, pp. 277-288, 2001.



Download PDF

Read 1043 times Last modified on Saturday, 01 March 2014 15:52