Nonlinear dynamics in foreign exchange rates Academic Article uri icon


  • This paper investigates whether the behavior of real and nominal foreign exchange rates as well as interest rates are governed by nonlinear dynamics; it also explores whether observed deviations from parity conditions exhibit nonlinear dependence. Standard statistical tests for randomness, such as autocorrelation tests, have low power against a large class of deterministic, nonlinear processes. Discerning nonrandomness of innovations in exchange rates is important for a variety of reasons. For example, many models of international asset pricing assume exchange rates to follow a random walk. Furthermore, nonlinear patterns in deviations from various exchange rate parities have implications for the existence of a time-varying foreign exchange risk premium. With the use of the BDS statistic and a correlation dimension analysis, this paper's primary findings are that (1) foreign exchange markets have become increasingly complex and therefore less amenable to forecasting over time; (2) although forward exchange risk premia are statistically significant and display a deterministic structure, this structure is complex and therefore not easily discernible; and (3) innovations in real exchange rates are consistent with a Purchasing Power Parity equilibrium. 1999 Elsevier Science Inc.

published proceedings

  • Global Finance Journal

author list (cited authors)

  • Mahajan, A., & Wagner, A. J.

citation count

  • 16

complete list of authors

  • Mahajan, Arvind||Wagner, Andrew J

publication date

  • January 1999