BUBBLES IN THE PHILIPPINE PESO-US DOLLAR EXCHANGE RATE: AN

APPLICATION OF THE GENERALIZED SUPREMUM AUGMENTED

DICKEY FULLER AND REGIME-SWITCHING MODEL

CELINE JOSON ALCANTARA

SUBMITTED TO THE FACULTY OF THE DEPARTMENT OF ECONOMICS

COLLEGE OF ECONOMICS AND MANAGEMENT
UNIVERSITY OF THE PHILIPPINES LOS BAOS
IN PARTIAL FULFILLMENT OF THE
REQUIREMENTS FOR THE
DEGREE OF

BACHELOR OF SCIENCE IN ECONOMICS

JUNE 2017

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 University of the Philippines Los Baos
COLLEGE OF ECONOMICS AND MANAGEMENT
College, Laguna

THESIS MANUSCRIPT

ECONOMICS 200

Thesis of : CELINE JOSON ALCANTARA

For the Degree of : BACHELOR OF SCIENCE IN ECONOMICS

Title : BUBBLES IN THE PHILIPPINE PESO-US DOLLAR

EXCHANGE RATE: AN APPLICATION OF THE
GENERALIZED SUPREMUM AUGMENTED DICKEY
FULLER AND REGIME SWITCHING MODEL

APPROVED : MARIA LUISA G. VALERA Reader __________, 2017

APPROVED : YOLANDA T. GARCIA Adviser __________, 2017

Department
APPROVED : AGHAM C. CUEVAS Chair __________, 2017

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APPROVED : ISABELITA M. PABUAYON Dean __________, 2017
BIOGRAPHICAL SKETCH

Celine Joson Alcantara was born on the 22nd of January in 1997 in the loving arms of
her parents, Ferdinand Alcantara and Edna Joson Alcantara. She is the eldest among her
sisters Trisha and Jazmine whom both have stood to be her best friends.

Celine finished her primary education in Colegio de San Benildo-Rizal. Although she
was one of the top of her class, she did not graduate with honors. Nevertheless, she was
admitted in Pasig City Science High School where she finished her secondary education.
She became the Biology Club president for two years and a member of the school
editorial paper as a feature writer.

Despite not having good grades in high school, she was reconsidered and admitted to
the University of the Philippines Los Baos under the degree program of BS Economics.
She spent four years in the university which has been her second home.

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 CELINE JOSON ALCANTARA
ACKNOWLEDGEMENTS

This thesis is the product of the knowledge imparted to me by the Department of

Economics, of the College of Economics and Management in UPLB. It has become my
home away from home for four years.

I am especially indebted to the professor who have inspired and introduced me to the
intellectual stimulating Econometrics, my adviser, Dr. Yolanda T. Garcia. Thank you for
the academic freedom, guidance, and trust throughout my thesis-writing process. I could
have not done it without you.

To my reader, Dr. Maria Luisa G. Valera, who have painstakingly read the work of
my sleepless nights in very short notices, thank you. You have been my second adviser
and made me felt like one of yours. To Prof. Rodger Valientes and Dr. Asa Sajise whom
both have served as my panelists, thank you for helping me improve my thesis to the best
it can be.

To my friends and batchmates who have been with me in this journey, thank you for
all the time we spent together, sharing both our lowest and highest moments. To Nicole,
Isobel, Joyce, Karen, and Sunshine, we all have finally made it. Thank you for hearing
me despite my silent cries.

Nobody has served me greater motivation to pursue my thesis but my family. Thank
you for being understanding even in the most unconventional ways. Thank you daddy
Ferdie for the support and time you lent me. It inspired me to finish my study on time
and especially make you proud. To my mom Edna, whom I have shared my anxiety
towards all my academic affairs, thank you. To Trisha and Jazmine whom I shared the
weight of all things, from school to home, thank you. Trisha, thank you for all the words
of love and support. Jazmine, thank you for knowing without the need of hearing from
me. You have become an ate to me when it was supposed to be the other way around. You
both are my strength.

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 TABLE OF CONTENTS

Page

BIOGRAPHICAL SKETCH iii

ACKNOWLEDGEMENTS iv

TABLE OF CONTENTS v

LIST OF TABLES vii

LIST OF FIGURES viii

ABSTRACT x

CHAPTER I. INTRODUCTION 1

CHAPTER II. REVIEW OF RELATED LITERATURE 5

A. Philippine Literature on Bubbles 5

B. Financial Crises 8

1. The Asian Financial Crisis 8

2. The Dotcom Crisis 9

3. The Global Financial Crisis 9

C. Determinants of Exchange Rates 10

D. Tests used in Determining Bubbles 11

1. Variance Bounds Test 11

2. Specification Test 12

3.Unit Root Test 13

4. Recursive Unit Root Test 14

5. Rolling Window Unit Root Test 15

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 6. Logarithmic Periodic Power Law Models 16

CHAPTER III. FRAMEWORK 19

A. Rational Bubbles 20

B. Heterogenous Bubbles 21

C. Behavioral Bubbles 21

D. Exchange Rate Determination Model 22

E. Conceptual Framework 24
F. Analytical Framework 25
CHAPTER IV. METHODOLOGY 26

A. Identifying Speculative Bubbles 26

1. Rolling Window Test 26

2. Date-stamping Strategy 28

3. Monte Carlo Simulation for Critical Values 29

B. Bubble Measure 30

C. Regime-Switching Model 31

D. Data 32

E. Analytical Tools 32

CHAPTER V. RESULTS AND DISCUSSION 33

A. Identifying and Date-Stamping of Bubble Episodes 35

B. Bubble Measure 37

C. Regime-Switching Model of Exchange Rate 39

CHAPTER VI. SUMMARY AND CONCLUSIONS 51

CHAPTER VII. LIMITATIONS AND RECOMMENDATIONS 54

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REFERENCES 55

LIST OF TABLES

Table Page

1 Summary statistics of PHP/USD exchange rate and its 34

gross return, 19932016.

2 GSADF test result. 35

3 Estimation of Exchange Rate Determination Model, 38

1993 2016.

4 Estimation result of the Regime-Switching Model of 40

PHP/USD exchange rate.

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 LIST OF FIGURES

Figure Page

1 Conceptual Framework for Bubbles in Exchange Rate. 24

2 Analytical Framework for Exchange Rate Bubbles. 25

3 Sample Sequence and Window Width for GSADF test. 27

4 Sample Sequence for BSADF test. 29

5 Logarithm of PHP/USD exchange rate, 19932016. 33

6 Gross Return of PHP/USD exchange rate, 19932016. 34

7 Date-stamping of bubble periods in the PHP/USD 36

exchange rate, 1993-2016.

8 Bubble Measure and Logarithm of PHP/USD exchange 38

rate, 19932016.

9 Bubble Measure and the identified bubble phenomena in 39

the GSADF test, 1993 2016.

10 Estimated Probability of Collapse relative to Interest Rate 43

and Bubble Measure, 19932016.
11 Estimated Probability of Collapse and Regime-Switching 44
to Collapse State relative to Interest Rate, 19932016.
12 Estimated Probability of a Collapse relative to 45
International Reserves and Bubble Measure, 19932016.
13 Estimated Probability of Collapse and Regime-Switching 46
to Collapse State relative to International Reserves,

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 19932016

14 Estimated Probability of Collapse relative to Exports and 47

Bubble Measure, 19932016.

15 Estimated Probability of Collapse and Regime-Switching 48

to Collapse State relative to Exports, 19932016

16 Estimated Probability of Collapse relative to Imports and 49

Bubble Measure, 19932016.

17 Estimated Probability of Collapse and Regime-Switching 50

to Collapse State relative to Imports, 19932016

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 ABSTRACT

Alcantara, Celine J. 2017. Bubbles in the Philippine Peso-US Dollar Exchange

Rate: An Application of the Generalized Supremum Augmented Dickey Fuller
and Regime-Switching Model. Undergraduate BS Economics Thesis. College of
Economics and Management, University of the Philippines Los Baos.

Thesis Adviser: Dr. Yolanda T. Garcia

Keywords: bubbles, exchange rates, financial crisis, generalized augmented dickey fuller

This study attempts to provide evidence of periodically collapsing bubbles in the

Philippine Peso-US Dollar exchange rate. Specifically, bubble is defined as the deviation
between market prices and its fundamental value that exhibits explosive behavior. In this
study, episodes of collapsing bubbles are identified using the Generalized Supremum
Augmented Dickey Fuller (GSADF) test. The finding suggests that there are periodically
collapsing bubbles present in the PHP/USD exchange rate. Specifically, these bubbles
coincide with known financial crises, the Asian Financial Crisis (AFC) in 1997, the
Dotcom crisis in 2001, and the Global Financial Crisis (GFC) in 2007.
Following the identification of significant bubble episodes using the GSADF test, a
bubble measure is approximated using an exchange rate determination model which uses
the concept of the purchasing power parity. The study then develops a two regime-
switching model that relates the expected gross return of exchange rate to the bubble size
and its explanatory variables. The two regimes used are the Survive state in which the
exchange rate grows with an explosive expectation, and the Collapse state in which
exchange rate does not have any explosive expectation. The explanatory variables used
are Exports, Imports, International Reserve, and Interest Rate. These variables are

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considered as Early Warning Signal (EWS) indicators for currency crisis. The probability
of collapse in the regime-switching model also concurs for the three identified crises:
AFC, Dotcom crisis, and GFC. The results further suggest that traded goods, the value of
exports and imports, are good EWS indicators for the possibility of collapse in the
PHP/USD exchange rate.

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