Nonlinearities and Real Exchange Rate Dynamics

We confirm the presence of substantial nonlinearities in real exchange rate dynamics at the sectoral level. There exists zones where arbitrage is not profitable because of transaction costs, and thus mean reversion is inexistent. We compute the speed of mean reversion of sector specific real exchange rates, conditional on the existence of arbitrage as implied by our nonlinear estimations, and relate them to plausible economic determinants such as tradability and exchange rate volatility. (JEL: F36, F41, C43) Copyright (c) 2003 The European Economic Association.