Threshold cointegration and nonlinear adjustment to the law of one price

Previous studies investigating threshold behavior in real-exchange-rate and price difference data have used rather ad hoc statistical methods and have focused on univariate threshold models for relative prices. We utilize a g eneral multivariate threshold cointegration model and develop a systematic testing and estimation strategy for this model, building on the work of oth ers. Using Monte Carlo experiments, we systematically compare the use of un ivariate and multivariate techniques for testing threshold cointegration, e stimating various threshold models, and testing specifications. We apply ou r methodology to a large set of U.S. disaggregated CPI data. We find eviden ce of threshold cointegration mainly for tradable goods. However, the type of threshold nonlinearity that we find generally does not support the trans action-cost view of commodity arbitrage.