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Specifying Smooth Transition Regression Models in the Presence of Conditional Heteroskedasticity of Unknown Form
01 Jan 2009-Research Papers in Economics (Lancaster University Management School, Economics Department)-
TL;DR: In this paper, the impact of conditional heteroskedasticity on Smooth Transition Regression models is examined and the performance of several robust versions of the Smooth transition regression model is investigated.
Abstract: The specification of Smooth Transition Regression models consists of a sequence of tests, which are typically based on the assumption of i.i.d. errors. In this paper we examine the impact of conditional heteroskedasticity and investigate the performance of several heteroskedasticity robust versions. Simulation evidence indicates that conventional tests can frequently result in finding spurious nonlinearity. Conversely, when the true process is nonlinear in mean the tests appear to have low size adjusted power and can lead to the selection of misspecified models. The above deficiencies also hold for tests based on Heteroskedasticity Consistent Covariance Matrix Estimators but not for the Fixed Design Wild Bootstrap. We highlight the importance of robust inference through empirical applications.
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TL;DR: The authors adopts a nonlinear framework to model the deviations of the real exchange rate from its fundamental value implied by International Real Business Cycle models with complete asset markets, and finds that in several cases there is a long run relationship between real exchange rates and consumption series in line with international risk sharing.
Abstract: This paper adopts a nonlinear framework to model the deviations of the real exchange rate from its fundamental value implied by International Real Business Cycle models with complete asset markets. By focusing on the post Bretton Woods era, we find that in several cases there is a long run relationship between real exchange rates and consumption series in line with international risk sharing. Further, linearity tests indicate that the majority of the deviation processes exhibit significant smooth transition nonlinearity. Exponential Smooth Transition Autoregressive models appear parsimoniously to capture the nonlinear adjustment. These findings provide an explanation for the empirical regularities noted in the literature on the relation between the real exchange rate and consumption, such as the Backus and Smith (1993) puzzle. Finally, Generalized Impulse Response functions show that shock absorption is significantly faster than suggested in the Purchasing Power Parity puzzle.
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