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Smooth structural breaks and the stationarity of the yen real exchange rates

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This article examines and solves an interesting paradox in the literature that the tests for purchasing power parity (PPP) based on the yen real exchange rates (RERs) refute the PPP hypothesis more often than those with other major currency-based RERs, and the evidence is sensitive to the sample period used. Using a new empirical methodology accounting for both nonlinearity and multiple smooth temporary breaks in the data, we show that the puzzling finding is due to the failure to take into account the long but temporary large rise and fall in the yen RERs. The results illustrate that the yen RERs in the post-Bretton Woods period are likely mean reverting with linear or nonlinear adjustment toward large, long swing type of infrequent smooth temporary changes around constant equilibrium values, supporting the validity of PPP and resolving the paradox.
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Keywords: C2; F31; PPP; large swings; nonlinear mean-reversion; unit root tests; yen real exchange rates

Document Type: Research Article

Affiliations: 1: Department of Economics, University of Texas at San Antonio, San Antonio, TX, 78249-0633, USA 2: Department of Economics, Southern Illinois University Edwardsville, Edwardsville, IL, 62026-1102, USA

Publication date: 2014-04-03

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