Mean Reversion in Long-Horizon Real Exchange Rates: Evidence from Latin America

Pablo Astorga

St Antony’s College, Oxford

Abstract

This paper analyses stability in real multilateral exchange rates in six leading Latin-American economies during the XXth century using a new data set. A univariate approach is complemented by an error-correction model including key fundamentals. Unit-root testing shows a very slow process of mean reversion – if any – in the series in levels; however, mean reversion is found after allowing for trends and structural breaks with half-life values ranges from 0.8 to 2.5 years. We also found reversion to a conditional mean defined by the co-integrating relationship, and that the equilibrium path is largely explained by fundamentals - especially terms of trade and trade openness. Exchange rate policy proved to have only a transitory effect in generating real depreciation.