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Abstract
In this article, we apply the recently developed threshold autoregression model to examine both linearity and stationarity of Italy's real exchange rate vis-à-vis her six trading partner (G6) countries. Our main finding is that Italy's real exchange rate is a nonlinear process that is not characterized by a unit root process for five of six trading partner countries. This provides strong support for purchasing power parity.
Acknowledgement
I am grateful to Bruce Hansen for making available his GAUSS codes for the TAR model, which were modified for the present exercise. However, any remaining errors are my own.
Notes
1 See also Taylor and Taylor (2004) for an excellent tour on PPP including discussions on nonlinearities in real exchange rates.