Econ.842 Term Paper The Exchange Rate in China
نویسنده
چکیده
The smooth threshold autoregressive (STAR) model is by far the most successful model in explaining the well-known two PPP puzzles. The nonlinearity in STAR captures the nature of vast transaction costs in trade, sunk costs in (foreign) investment, and hetergeneity in agents. In this paper, we use a variant of STAR, the Exponential STAR (ESTAR), to study the exchange rate dynamics in China during 1979 2006. First, we use a general equilibrium model that considers both internal and external balances to estimate the equilibrium exchange rate. Then, we identify that the best ESTAR for Chinas exchange rate should be one time lag and one time delay model. Given the estimated parameters from nonlinear least square, simulation suggests that the half-life of 50% shock is slightly more than 2 years. Roughly speaking, a deviation of 10% or more from equilibrium level will be facing heavy arbitrage pressure. Keywords: equilibrium exchange rate, PPP JEL Classi cation: F31, F37
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