Document Type

Working Paper

Date of This Version



real exchange rate dynamics, nonlinear dynamics, smooth transition estimation, Monte Carlo analysis

JEL Classification

F41, F47, C15, C32


This paper investigates nonlinearities in the dynamics of real exchange rates. We use Monte Carlo simulations to establish the size properties of the Teräsvirta-Anderson (1992) and the Teräsvirta (1994) test, when the dynamics of the real exchange rate is influenced by an exogenous process. In addition, we examine the modification proposed by Ahmad, Lo and Mykhaylova (2013; Journal of International Economics) to show that the modified nonlinearity test performs much better than the original in both Monte Carlo exercises and in the actual data on 1431 bilateral real exchange rate series. Finally, we investigate the dynamics of the real exchange rate for both developed and developing countries using the modified test for the recent floating period. In general, the results finds a greater incidence of nonlinear dynamics for developing country real exchange rates.

Working Paper Number