The dynamics of real exchange rates – A reconsideration

While it is widely agreed that Purchasing Power Parity (PPP) holds as a long-runconcept the specific dynamic driving the process is largely build upon a priori economicbelief rather than a thorough statistical modeling procedure. The two prevailing timeseries models, i.e. the exponential smooth transition autoregressive (ESTAR) model andthe Markov switching autoregressive (MSAR) model, are both able to support the PPPas a long-run concept. However, the dynamic behavior of real exchange rates impliedby these two models is very different and leads to different economic interpretations.In this paper we approach this problem by offering a bootstrap based testing procedureto discriminate between these two rival models. We further study the small sampleperformance of the test...