'Tests for Nonlinearity in EMS Exchange Rates' - Abstracts

Tests for Nonlinearity in EMS Exchange Rates

Jon Vilasuso
Department of Economics and Finance
Clarkson University

Steve Cunningham
Department of Economics
University of Connecticut


Pages 155-168

Abstract

This paper tests for nonlinearity in EMS exchange rates using the bispectrum. The early experience of the ERM witnessed numerous realignments. We find that exchange rates follow a linear process over the period 1979-1987, consistent with the predictions of the realignment target zone model, where a stabilizing nonlinearity is absent. But from 1987-1992, no realignments occurred, and many currencies conformed to a nonlinear process, consistent with the credible target zone model where an inherent nonlinearity stabilizes exchange rates. However, the Italian lira and the Irish pound follow a linear process, which suggests that a target zone has not proven effective in stabilizing exchange rates.

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