EXCHANGE RATES AND INTEREST RATES IN MEXICO: A MARKOV REGIME-SWITCHING APPROACH.

A Markov regime-switching model is applied to the time series of the Mexican Peso-U.S. Dollar exchange rate and to the Mexican interest rate. The existence of two states is statistically significant in both cases. The exchange rate is characterized by extended periods of low variance and slight appreciations followed by short-lived high variance and depreciation states. The interest rate is characterized by a long run decrease in interest rates that can be decomposed in two periods: one with high rates and increased volatility before 2004 and another with low rates and decreased volatility after that year. It was found that the states of these time series are in sync 44.9% of the time due mainly to the persistence of the states rather than due to the correlation between the high volatility-depreciation state in exchange rates and the high volatility state in interest rates. [ABSTRACT FROM AUTHOR]