Real exchange rates and switching regimes

We suggest that the real exchange rate between the major currencies in the post-Bretton Woods period can be described by a stationary, 2-state Markov switching AR(1) model. Based on the forecast performance we find that this model outperforms two competing models where the real exchange rate is nonstationary. We also find that the existence of different regimes, as in the Markov switching model, is consistent with the common finding of unit roots in real exchange rates.