Is economic exposure asymmetric between long-run depreciations and appreciations? Testing using cointegration analysis

Theoretical models of pricing-to-market suggest that the profile of economic exposure may be asymmetric between periods when the real exchange rate appreciates and periods when it depreciates. We test this hypothesis using time-series data on export prices for eight commodities exported from the UK to the US during the period 1981-1988. During this period, there was a long-term real depreciation of the £ against the $ (1981 I-1985 I) followed by a long-term real appreciation (1985 II-1988 IV). To test for cointegration between the export price of each commodity and the real exchange rate, we apply the Phillips and Ouliaris (1990) and Johansen and Juselius (1990) methods. As the latter allows linear restrictions on the cointegrating vector to be imposed and tested for directly, we adopt the Johansen and Juselius method and impose a linear restriction on the cointegrating vector to test for asymmetry. The results are generally in favour of this hypothesis. The implication for financial hedging against economic exposure is that currency options should be preferred to forwards, futures or swaps contracts. © 1997 Elsveier Science B.V.