Mean reversion in bilateral real exchange rates: evidence from the Malaysian ringgit

This study examines behaviour of the Consumer Price Index (CPI)-based Real Exchange Rates (RERs) of the ringgit against the currencies of Malaysia's major trading partners. The empirical results, which are derived from newly developed tests advocated by Lee and Strazicich (LS, 2003) and Narayan and Popp (NP, 2010) that allow for two breaks in the series, provide conflicting results. We obtain weaker support for Purchasing Power Parity (PPP) using the Narayan and Popp (2010) test. By truncating the sampling period into two sub-periods, we find that PPP holds for majority of the Malaysia's bilateral exchange rate vis-a-vis its major trading partners during the pre-crisis period. The 1997 currency crisis, however, has weakened the evidence in favour of PPP hypothesis in the strict sense.