Random walk and structural break in exchange rates

Abstract

In this paper, our goal is to examine whether foreign exchange rate between the US and her largest trading partners (China, Canada, Mexico, Japan, Europe, South Korea, UK, India and Taiwan) follow random-walk or mean-reversion processes in the presence of sudden and gradual structural break. Our tests endogenously determined the structural swing and are more powerful than the traditional unit root tests. In all foreign exchange rates, we find strong evidence for structural breaks. Moreover, the results are consistent with the random-walk hypothesis for all trading partners except China. After due allowance is made for structural break, the Chinese yuan against the US dollar violate the random walk hypothesis.