Desventajas de las etiquetas

The main findings of the review of the theoretical and empirical literature of asymmetric and nonlinear ERPT into consumer prices are summarised as follows: The situations recognised in the theoretical literature that could create asymmetric/nonlinear exchange rate pass-through include market share objective, capacity constraint, menu costs, production switching, stage of the business cycle and monetary policy reactions. As we described in the discussion, all these behavior are prevalent among importing firms in Nigeria that opened up for trades not very long ago, and most of the foreign importing firms are at early stages of growth.

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The empirical studies confirmed the existence of asymmetry and nonlinearity are mainly from countries like India and South Africa that share same geographical and structural features with Nigeria.

Only very few studies examined non-linear and asymmetric ERPT using data from emerging and developing economies which might be because most developing countries have no sufficient data available. For instance, there was no research on nonlinear and asymmetric exchange rate pass-through using Nigeria data.

Considering the lack of any study of asymmetric and nonlinear ERPT on Nigeria, this study aims to fill this literature gap in Nigeria. Given the increased globalisation and Nigeria’s financial and trade liberalization policies (see Section 2.2, chapter 2) studying the asymmetric and nonlinear ERPT is essential. The foreign companies in Nigeria tend to have market share objectives, capacity constraints, and often switch their sources of input and also consider the cost of changing the menu, it is therefore imperative to examine how the behaviours of the foreign firms affect the exchange rate pass-through process. Therefore, chapter seven of this thesis examines the asymmetric and nonlinear exchange rate pass-through in Nigeria using a quarterly time series data from 1986 to 2013 by applying a STAR model to fill this study gap.

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Chapter 5 :

Research Methodology

5. 1 Introduction

The aim of this chapter is to discuss the models used in this thesis, the Vector error correction model (VECM) and the Smooth transition autoregressive model (STAR) and the strength of the models. The econometric methods used to model ERPT in the literature can generally be classified into single equation models and system models. Most early studies used single equation models for the exchange rate pass- through estimation on aggregated data (for example see, Feinberg 1986, Marston 1990, Menon 1992). Some of the early ERPT studies using the single equation with non-stationary3 data produced wrong conclusions as exchange rate and price series are often non-stationary (Aron et al., 2014). However, the linear combination of non-stationary variables can still produce a valid result, if the non-stationary variables are co-integrated4. Most of the later studies resolve the issue of non- stationarity by differencing the data to generate stationary series. Although, with a differenced data, it implies that the study either assumes there is no long-run relationship between the variables or a test for the relationship did not show any (See Campa and Goldberg, 2005).

Most of the single equations used are based on reduced-form regressions from a partial equilibrium model, based on the assumption that exchange rates are exogenous, which suggests that changes in the exchange rate are exogenous shocks. The single equation methods have the advantage of testing asymmetries and other

3 _{Using non-stationary data are likely to produce incorrect results as regression equations using non-} stationary variable can produce spurious correlations (Granger, 1981).

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nonlinearities, in the ERPT process directly using split trends and interaction effects, or with explicitly non-linear versions. On the other hand, the systems models allow the endogeneity of the exchange rate and price variables which give room for feedback effects (Aron et al., 2014).

When there are no structural breaks and nonlinearities in the sample data, the Johansen systems method (Johansen & Juselius, 1990), a vector autoregressive (VAR) model system in levels, can be used to test for multiple, long-run, co- integrating relationships between the hypothetically endogenous I(1) variables (Aron

et al., 2014).

The VAR models are helpful as it allows for the interaction of exchange rate with domestic variables (Ito and Sato, 2006). A Cointegrated VAR (CVAR) also known as Vector error correction model (VECM) is an excellent tool for both the short and the long-run relationship analysis which also resolves the problem of endogeneity and ‘reverse causality’.

In the VECM, the speed of adjustment to equilibrium is independent of the magnitude of disequilibrium. The nonlinear adjustment could be modelled using threshold autoregressive (TAR) model (Tong 1993). TAR would be suitable when there is a threshold level of the absolute deviation from equilibrium beyond which exchange rate becomes mean reverting. The nonlinear adjustment process could also have features of a smooth transition autoregressive (STAR) model (Teräsvirta, Tjostheim and Granger 2010). In the STAR model, the fixed thresholds of the TAR model are substituted with a smooth function, which is continuous and non- decreasing (Tong 1993). In this study, we thought a Smooth transition

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autoregressive (STAR) model is more suitable than the TAR model when examining the exchange rate pass-through to consumer prices.

The STAR models have some useful properties. For instance, the STAR model does not imply an abrupt switch from one regime to another as the TAR model. The level and speed of exchange rate pass-through depend on the importing firm’s perception of the exchange rate changes (whether permanent or temporary) and other factors like menu cost, market share objective and capacity constraints of the firms. Hence a smooth transition could be more suitable. Considering a large number of firms with different objectives and perceptions their reaction to the changes in the exchange rate could not be simultaneous. Accordingly, Teräsvirta (1994) noted that regime change for aggregated processes could not be discrete but smooth. STAR models also nest linear regression model, hence a linear Lagrange multiplier (LM) tests could be used to check for linearity prior to the nonlinear model application (Teräsvirta 1994). The LM tests can also be used to choose between the alternative STAR specifications, logistic STAR (LSTAR) and exponential STAR (ESTAR). The asymmetry in response to a positive and negative change in the exchange rate can be appropriately examined by the ESTAR model, while the nonlinear response to the size of the changes in exchange rate, inflation environment and growth levels could be examined with LSTAR as described by Teräsvirta (1994).

This study uses the VECM to examine the level and speed of the transmission of exchange rate changes to consumer prices in chapter six. While in chapter seven, we use STAR model to examine the impact of asymmetries and nonlinearities in the exchange rate pass-through process in Nigeria.

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This chapter is divided into three sections discussing the two models adopted for the two empirical studies and drawing a conclusion. In section one, the VECM model is introduced, and some essential econometric issues in a VECM application like stationarity, cointegration, structural break and evaluations are discussed. In the second section, the STAR model is discussed explaining the modelling approach of the model. In section three a conclusion is drawn on how to apply the models in this study.