Nonlinear Error-Correction Models for the FF/DM Rate

This paper is devoted to the empirical analysis of the dynamic behaviour of the FF/DM parity during the September 1987-July 1993 period. By explicitly allowing the strength of adjustment to vary with the extent of equilibrium error, we successively perform parametric, semiparametric and nonparametric estimations of the functional form of the nonlinear error-correction term. On the basis of these econometric tools, we highlight a stronger correction of positive deviations of the parity from the level consistent with its macroeconomic fundamentals and a nonlinear reversion towards a set of equilibrium exchange rates. This asymmetric adjustment of deviations from equilibrium discloses a reluctance for the undervaluation of the FF over the period.