The long-run relationship between real exchange rate and real interest rate in Asian countries: An application of panel cointegration

Abstract

The study employs the Johansen cointegration and panel cointegration techniques to explore the long-run relationship between real exchange rate and real interest rate differential for the case of ten Asian countries, for the period 1970-2000. The empirical results using Johansen's cointegration technique provide strong evidence to reject the null-hypothesis of non-cointegration in most of the developing countries. The trace statistics of Johansen's cointegration method indicate evidence of cointegration between real exchange rate and real short-run interest rate differential in the case of nine out of ten Asian countries. Whereas cointegration between real exchange rate and real long-run interest rate differential appears in five cases, according to trace statistics of Johansen method, the empirical results using panel cointegration method provide evidence of statistically significant long-run relationship for one currency pairing. Therefore, the results of panel cointegration test support the results for individual country Johansen's test for the existence of long-run relationship between real exchange rate and real interest rate differentials.