Testing And Identifying Multiple Bubbles In Pak Rupee-Chinese Yuan Exchange Rate

Abstract

This research investigates the presence of rational bubbles within the time series data of the Pakistani Rupee (Pak Rupee) and Chinese Yuan exchange rate. Its main objectives are to evaluate the efficacy of various econometric tests in identifying explosive behavior and to determine their applicability in assessing exchange rate dynamics. Additionally, the study seeks to elucidate the key drivers contributing to the emergence of explosive behavior in the Pak Rupee-Yuan exchange rate. Employing the Augmented Dickey Fuller (ADF), Sequential Augmented Dickey Fuller (SADF), and Generalized Sequential Augmented Dickey Fuller (GSADF) tests, the research reveals that the ADF test successfully identifies explosive behavior in the exchange rate, while the right-tail ADF test fails to do so for both traded and non-traded goods, leaving the origin of the exchange rate's explosive behavior inconclusive. Similarly, the SADF test mirrors these results, confirming explosive behavior in the exchange rate but not in traded and non-traded goods. However, the GSADF test detects multiple bubbles in the exchange rate and identifies explosive behavior in traded goods. Notably, it fails to identify multiple bubbles in non-traded goods, suggesting that the exchange rate's explosive behavior primarily stems from the non-traded goods sector. In summary, the study concludes that the GSADF test effectively identified the fundamental driver responsible for the explosive behavior in the exchange rate, namely non-traded goods. In contrast, the right-tail ADF and SADF tests were unable to ascertain these underlying drivers.