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Sovereign risk and the real exchange rate: A non-linear approach

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  • Ojeda-Joya, Jair N.
  • Sarmiento, Gloria
Abstract
We estimate a model of real exchange rate determination which is based on interest rate, term structure and purchasing power parities. This model takes into account sovereign risk as a key determinant with possibly non-linear effects. Estimations are performed for five Latin-American economies: Brazil, Chile, Colombia, Mexico and Peru. The results show that the model has good fit for all countries and the expected sign holds for most estimated coefficients. In particular, it is found that sovereign risk has a significantly positive relation with the real exchange rate. There is evidence of the non-linearity of this relation for Brazil, Colombia and Peru. This non-linearity implies coefficients that change with smooth transition as a function of international volatility indicators. In addition, we perform misalignment analyses and show that real exchange rates became over-depreciated during the initial development of the great financial crisis. Then, between 2011 and 2013, they went through a few periods of over-appreciation as international monetary and fiscal policies became expansive and international capital flows were bound to emerging economies searching for higher yields. Finally, the strong reduction of commodity prices led to a new over-depreciation episode during the second half of 2015 in most economies.

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  • Ojeda-Joya, Jair N. & Sarmiento, Gloria, 2018. "Sovereign risk and the real exchange rate: A non-linear approach," International Economics, Elsevier, vol. 156(C), pages 1-14.
    • Handle: RePEc:eee:inteco:v:156:y:2018:i:c:p:1-14
    DOI: 10.1016/j.inteco.2017.05.003
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    2. Ojeda-Joya, Jair & Romero, José Vicente, 2023. "Global uncertainty shocks and exchange-rate expectations in Latin America," Economic Modelling, Elsevier, vol. 120(C).
    3. Reinhold Heinlein & Gabriella D. Legrenzi & Scott M. R. Mahadeo & Gabriella Deborah Legrenzi, 2024. "Exchange Rates and Sovereign Risk: A Nonlinear Approach Based on Local Gaussian Correlations," CESifo Working Paper Series 11019, CESifo.
    4. Ifedolapo Olabisi Olanipekun & Godwin Olasehinde-Williams & Hasan Güngör, 2019. "Impact of Economic Policy Uncertainty on Exchange Market Pressure," SAGE Open, , vol. 9(3), pages 21582440198, September.

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    More about this item

    Keywords

    Real exchange rate; Misalignment; Sovereign risk; International parities; Latin America; Smooth transition regression;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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