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Nov
2013

Performance of CHEERs Based Equilibrium Exchange Rate of Pakistan: Literature Review

Performance of CHEERs Based Equilibrium Exchange Rate of Pakistan: Literature ReviewThe results of (Clostermann & Schnatz, 2000) showed a slow convergence in the equilibrium of Euro/Dollar Exchange Rate using the PPP and UIP. These stated papers proved that the CHEERS model works well inside the given sample.

While testing outsample perfornance of the model, (Clostermann & Schnatz, 2000) compares the forecasts of this model with the forecasts of Random Walk model and Moving Average model, the results were opposite to what whould be expected after insample performance, the models was not able to outforecast the RW or MA model.

For the case of Pakistan, (Kemal & Haider, 2004) tested PPP against several countries USA, UK, Euro and Japan. The results showed the against the existence of PPP as the Real Exchange Rate came out to be non-stationary. As per UIP, (Kemal & Haider, 2004) found correlation among the Nominal Exchange Rate and the nominal Interest Diffential.

(Qayyum, Khan, & Kair-u-Zaman, 2004) used PPP to estimate the degree of misalignment of Exchange Rate as mentioned a high cost of misalignment in work done in 1990’s and 2000’s. using Vector Error Correction Model they found out cointegration with unit elasticity in PPP. But the effects of shocks disappear after a long time due to of slow convergence speed. (Qayyum, Khan, & Kair-u-Zaman, 2004) reasoned trade libralization policies of Pakistan in 1980’s for the accpetence of Law of One Price.

Similar work done by (Khan & Qayyum, 2007) found no mean reversion on the basis of simple stationarity test of Real Exchange Rate but after using the Johanson-Juselius Multivariate Cointegration test, results found convergence in PPP based Exchange Rate model with around 12% correction per quarter.

(Ahmad, 2005) used SAARC coutrries like Pakistan, India and Bangladesh and looked for the presence of Purchasing Power Parity using several non-regression based tests. And for the data range of 1975Q1 to 1981Q4, (Ahmad, 2005) proved the presence of relative version of the PPP in Pakistan.

Most of the papers that considered the PPP and UIP in the co-integration set are work done by foreign authors and on the other hand, domestic papers did not considered UIP to be incorporated in the estimated relationship so this paper will bring VECM approach and apply the CHEERs based framework on the Exchange Rate of Pakistan/USA and see the performance of the model and the implications that the Equilibrium Exchange Rate brings with it.

Following section will provide insight to the mathematical model that (Ahmad, 2005) and (Juselius & MacDonald, 2004) and provide the final mathematical relationship between the nominal Exchange Rate, Price Differential and the Interest Differential, that is known as CHEERs model. This paper will estimate the model built from (Juselius & MacDonald, 2004) which integrates UIP and PPP for the case of Pakistan which was missing in the all the studied which are done for Pakistan.

The results of (Clostermann & Schnatz, 2000) showed a slow convergence in the equilibrium of Euro/Dollar Exchange Rate using the PPP and UIP. These stated papers proved that the CHEERS model works well inside the given sample. While testing outsample perfornance of the model, (Clostermann & Schnatz, 2000) compares the forecasts of this model with the forecasts of Random Walk model and Moving Average model, the results were opposite to what whould be expected after insample performance, the models was not able to outforecast the RW or MA model. For the case of Pakistan, (Kemal & Haider, 2004) tested PPP against several countries USA, UK, Euro and Japan. The results showed the against the existence of PPP as the Real

About The Author

Kevin J. Brandon

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