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THE REAL INTEREST RATE DIFFERENTIAL: INTERNATIONAL EVIDENCE BASED ON NON‐LINEAR UNIT ROOT TESTS
Author(s) -
Baharumshah Ahmad Zubaidi,
Liew Venus KhimSen,
Haw Chan Tze
Publication year - 2009
Publication title -
bulletin of economic research
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.227
H-Index - 29
eISSN - 1467-8586
pISSN - 0307-3378
DOI - 10.1111/j.1467-8586.2008.00288.x
Subject(s) - unit root , unit root test , econometrics , mean reversion , economics , parity (physics) , exchange rate , interest rate parity , real interest rate , differential (mechanical device) , purchasing power parity , statistics , interest rate , mathematics , macroeconomics , cointegration , engineering , physics , aerospace engineering , particle physics
This paper aims at testing international parity conditions by using non‐linear unit root tests advocated by Kapetanios et al . (2003, KSS). Results from the KSS tests based on 17 countries (G7 and 10 Asian countries) overwhelmingly show that the adjustment of real interest rates towards real interest rate parity (RIP) follows a non‐linear process except for the Taiwan, Hong Kong and Philippines relationships with both the USA and Japan. Overall, the empirical results are in favour of RIP using the USA and Japan as the centre countries but only if non‐linearities are accounted for in the data‐generating process. Our findings confirm that interest rate differentials, like the real exchange rates reported in recent literature, display a non‐linear mean reversion process.