Long memory and mean reversion in real exchange rates in Latin America

ABSTRACT

This article examines the long-run Purchasing Power Parity (PPP) hypothesis for 12 Latin American Real Effective Exchange Rates (REERs) using fractional integration techniques. The empirical results, applying parametric approaches, provide evidence of mean reversion in the REERs in the cases of Nicaragua, Belize, Costa Rica, Guyana and Paraguay and lack of it for the remaining seven countries. Employing semiparametric methods, the evidence of mean reversion covers the following countries: Belize, the Dominican Republic, Ecuador and Mexico. Thus, only for Belize and Guyana do we obtain consistent evidence of mean reversion in the real exchange rates. At the other extreme, lack of mean reversion, and thus, lack of PPP, is obtained with both methods in Bolivia, Brazil, Colombia and Venezuela. For the remaining six countries, the results are ambiguous. The results for the PPP theory in Belize and Guyana may show the importance of promoting policies based on exchange rate flexibility and economic liberalization to reach a long-run stability scenario that leads to greater international competitiveness and lower external vulnerability.

KEYWORDS:

• Real exchange rates
• Purchasing Power Parity
• fractional integration
• long memory
• mean reversion

JEL CLASSIFICATION:

• C12
• C22
• F31

Acknowledgement

Comments from the editor and an anonymous reviewer are gratefully acknowledged.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ In other words, we impose α = β = 0 in Equation (1) in case (i); α unknown and β = 0 in Equation (1) in case (ii) and both α and β unknown in case (iii).

² Though the data are seasonally adjusted, based on its quarterly nature, we allow for the model: u_t = δu_t−1 + ε_t, with white noise ε_t.

³ Some attempts to solve this issue has been proposed, see e.g. Henry (2007).

Additional information

Funding

This work was supported by the Ministerio de Economía y Competitividad [ECO2014-55236].