Real Exchange Rate Persistence: The Case of the Swiss Franc-US Dollar Rate

Abstract

Asset prices tend to undergo wide swings around long-run equilibrium values which can have detrimental effects on the real economy. To get a better understanding of how the financial sector and the real economy interact this paper models the long swings in the Swiss franc-US dollar foreign currency market using the I(2) Cointegrated VAR model. The results show strong evidence of self-reinforcing feedback mechanisms in the Swiss-US foreign exchange market consistent with the observed pronounced persistence in the Swiss-US parity conditions. Generally, the results provide support for models allowing expectations formation in financial markets to be based on imperfect information.

Keywords: Long swings, Imperfect Knowledge, I(2) analysis, Self-reinforcing feed-back

JEL Classification: C32, C51, F31