Foreign Exchange Rates, Asymmetric Adjustment and Threshold Co-integration: Empirical Evidence from Canada

Abstract

This paper provides an empirical analysis of the adjustment process that exists in the foreign exchange market, especially, between spot exchange rates and foiward exchangerates. This paperuses monthly observations ofCanadian and U.S. dollar exchange rates for the period of! 973-1994. Employing the threshold auto-regression and threshold co-integration methodologies; our findings indicate the presence of a strong asymmetric adjustment process. This adjustment process is more persistent when the exchange rate differential is positive. Although, we have found the existence of a weak threshold co-integrating relationship between the current spot rates and expected future rates, the error correction estimation does not provide us with any conclusive inference about the process ofadjustment. These results imply that the Central Bank ofCanada may formulate amore appropriate policy regarding intervention in the foreign exchange market (F31,C22).