A non-parametric analysis of ERM exchange rate fundamentals

Abstract

In this paper we present evidence concerning the number of common stochastic trends in three major ERM exchange rates. The results indicate the presence of a single common trend driving these currencies and from this we suggest that the common trend can be considered as the non-parametric fundamentals for the three selected currencies. Using a non-parametric technique, the Alternating Conditional Expectations (ACE) algorithm, we obtain evidence for the existence of non-linearities for two out of three currencies with a functional form, related to the estimated non-parametric fundamentals, close to the S-shape given by the basic target zone model.