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The author is grateful to Michael Devereux, Hamid Davoodi, Luiz de Mello, Anastassios Gagales, Eswar Prasad, Marijn Verhoeven, and seminar participants at the Ohio State University and Bloomsbury brown-bag meeting for their insightful comments. Special thanks are due to Masao Ogaki, for his helpful advice.
In many applications, τ=0. But this paper uses an application in which τ>0.
As shown in Section V, the statistical evidence against this money demand function is weak; so this assumption on income elasticity is not strong.
Tests for the null of cointegration based on CCR assume that there is only one cointegrating vector and hence cannot be used in the case of multiple cointegrating vectors. Johansen’s ML method has an advantage that it allows multiple cointegrating vectors. However, as pointed out by Ogaki (1993a) and among others, cointegrating vectors may not be identified even by the Johansen’s ML method.
The weight for country 1 is calculated as Weight1t=
As to e(t)+p*(t)−p(t), Park’s J(0,3) test is applied to test the null of its difference stationarity against the alternative of its stationarity. The test does not reject the null at any reasonable level of significance, which is consistent with the assumption.
To save space, some of the parameter estimates are not reported in Table 4. These estimates are available upon request.
Discussion on the forward premium bias is beyond the scope of this paper. See Froot and Thaler (1990) and Eichenbaum and Evans (1995) for detailed discussions. Konuki (1999) conducts a race between risk-premium models in terms of their ability to explain observed violations of UIP.
It is pointed out that external factors, such as a portfolio shift into Swiss francs caused by doubts about the ECU, have exacerbated the appreciation (IMF (1994)).
Some caution is required in interpreting the results of these simulations. The estimated value of real exchange rate’s multiplier might be biased upwards due to the specification of aggregate demand.