Research On The Changes Of Relation Between Rmb Interest Rate And Exchange Rate Based On Star Model

Interest rate and exchange rate, which are the internal and external prices of currency, have close relation with each other, and they are the core variables for a country's economy as well. Since the subprime crisis in 2007, the international economic system has been influenced greatly, and the interest rate differentials and exchange rate for RMB have experienced a fluctuation during that period. Based on the mean reversion of interest rate and exchange rate, the paper employs the STAR model to analyze the relation between the real interest differentials and real exchange rates. The research can be useful for the policymakers for effective"interest rate-exchange rate"policy to keep the economy stable and reduce the jeopardy of the crisis.This paper first reviews the literature in research of the relation between interest rate and exchange rate, analyzes the theories and models in interest rate and exchange rate relation changes research, and then gives a description of the mean reversion. Considering the mean reversion phenomena in both interest rate and exchange rate, a method based on the STAR process is used to analyze the relation change between interest rate and exchange rate. A time serie, which equals the change of real interest rate minus the change of the real exchange rate, is used in this paper. Finally, the paper applies Chow test to find out the breakpoints for regime transitions.The paper applies monthly data over the sample for the countries, which have the most transactions in international business and capital market, and employes the synthesized interest rate differentials and real effective exchange rate in the empirical study. Using the regime transition function simulated through STAR model, and the breakpoints test analysis in the flunction process to distinguish the extent of regime transtion in different countries. Also it is concluded that the subprime crisis fluctuated the economy system between China and other countries, and the breakpoints for different countries can be exposed during the crisis, so there is proof to prove the regimes transition from old regimes to the new ones. Meanwhile, the relation between various currencies and RMB is different, that is the reason for the different regime transition for different countires.