Real interest rate parity in East Asian countries based on China with nonlinear threshold unit-root test

Abstract

This study applies nonlinear threshold unit-root test to assess the nonstationary properties of the Real Interest Rate Parity (RIRP) for 10 East Asian countries relative to China. We find that nonlinear threshold unit-root test has higher power than linear method suggested by Caner and Hansen (2001) if the true Data-Generating Process (DGP) of real interest rate convergence is in fact a stationary nonlinear process. We examine the validity of RIRP from the nonlinear point of view and provide robust evidence that clearly indicates that RIRP holds true for eight countries in this region. It implies that the choices and effectiveness of the monetary and fiscal policies in the East Asian economies will be highly influenced by external factors originating from China. Also, our findings point out their real interest rate convergence relative to China is mean reversion towards RIRP equilibrium values in a nonlinear way.