Nonlinear Econometric Approaches in Testing PPP of SADC Economies towards Monetary Union

Working paper 420
Author(s): 
Mulatu F. Zerihun, Marthinus C. Breitenbach and Francis Kemegue
Publication date: 
February, 2014
Journal: 
Economic Modelling
Classification-JEL: 

The theory of purchasing power parity implies that real exchange rate series should be stationary. However, conventional unit root tests on the Southern African Development community (SADC) real exchange rates confirm the existence of a unit root. Such deficiencies in the investigation of the dynamics of real exchange rates in the region calls for nonlinear methods like the method used in this study to be pursued, which may better explain the dynamics of real exchange rates in SADC. In this paper two nonlinearity tests are employed: the nonparametric test developed by Brock, Dechert, and Scheinkman - known as the BDS test and the Fourier stationarity test. The BDS test detects the independent and identically distribute (iid) assumption of the time series used in the analysis while the Fourier approximation mimics a wide variety of breaks and other types of nonlinearities. Both tests confirm the non-linear nature of real exchange series in SADC. The result from the Fourier stationarity test further provides strong evidence of an OCA among the 11 SADC countries included in the study

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