Nonlinear mean reversion in real exchange rates: threshold autoregressive models and stochastic unit root processes

Threshold-type nonlinear relations are pretty popular in modelling the deviations from purchasing power parity. This article shows that there is a close relation between the nonlinear band Threshold Autoregressive (TAR) models studied by Obstfeld and Taylor (1997) and Stochastic Unit Root (STUR) processes discussed by Granger and Swanson (1997) and McCabe and Tremayne (1995). Employing the real exchange rates from four major countries against the US dollar, this article finds little evidence for TAR but some support for STUR during the post-Bretton Woods sample periods.