An empirical investigation of rational bubbles in US dollar-Turkish lira exchange rate by means of currency derivative market

This study aims to investigate whether USD/TRY exchange rate exhibits any rational 'speculative' bubble formations over the period 2001-2022. As a rational bubble in any asset price is defined as consistent deviations of prices from its fundamental value, testing for bubbles using some statistical techniques might be straightforward under the assumption that model specification for fundamentals is correct. However, given parameter and model uncertainties about model specification for fundamentals, one can never be certain about the results of the tests based on fundamental specifications to conclude the presence of rational bubbles or model misspecification because rejecting the null hypothesis might point to either or both of these cases. Recently, the study by Pavlidis, Paya, and Pell (2017) propose a method for testing rational bubbles, which they argue, does not depend on model specification for fundamentals. Their method simply looks at the spot-forward rate deviations. One can see if such deviations are explosive such that periodically collapsing bubbles are present by means of right-tailed unit root tests (GSADF test) developed by Phillips et al. (2015). This study adopts the method of Pavlidis et al. (2017) by applying GSADF tests to differences of spot-forward USD/TRY exchange rates in order to investigate the existence of rational bubble formations in USD/TRY exchange rate. We find that although the spot rate itself presents excessive behavior, especially after 2014, spot-forward differentials are not explosive, meaning that there is no evidence of rational 'speculative' bubbles in USD/TRY exchange rate over the sample period.