An Empirical Analysis of Nonstationarity in Panels of Exchange Rates and Interest Rates with Factors
50 Pages Posted: 16 Nov 2005
Date Written: August 2005
Abstract
This paper studies nonstationarities in panels of exchange rates and interest rates. For this, we survey developments in the analysis of nonstationary panels with cross-sectional dependence modeled as a factor model. We focus on panel unit root tests and on inference on the nonstationary factors.
Our results suggest that PPP does not hold for our panel of 17 exchange rates due to the presence of nonstationary factors. The dominant factor has a very strong European flavor. Moreover, we find a single nonstationary factor in a panel of Canadian and U.S. interest rates of different maturities and risk. Since some of the idiosyncratic components are stationary, these series are cointegrated. The dominant factor has a level interpretation as in the term structure literature.
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