Common Stochastic Trends in a System of Exchange Rates

Authors

  • RICHARD T. BAILLIE,

  • TIM BOLLERSLEV

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    • Department of Economics, Michigan State University and Department of Finance, Northwestern University, respectively. We are grateful for discussions with Mark Watson and for the very helpful comments from René Stulz and the referees on an earlier version of the paper. Paula Nielsen and Angie Campbell did an excellent job typing the manuscript. Any remaining errors are the authors' responsibility.


ABSTRACT

Univariate tests reveal strong evidence for the presence of a unit root in the univariate time-series representation for seven daily spot and forward exchange rate series. Furthermore, all seven spot and forward rates appear to be cointegrated; that is, the forward premiums are stationary, and one common unit root, or stochastic trend, is detectable in the multivariate time-series models for the seven spot and forward rates, respectively. This is consistent with the hypothesis that the seven exchange rates possess one long-run relationship and that the disequilibrium error around that relationship partly accounts for subsequent movements in the exchange rates.

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