An empirical examination of the purchasing-power-parity hypothesis for Denmark 1875-2002

The paper reviews the empirical evidence regarding long-run relative purchasing-powerparity (PPP) convergence in the case of Denmark using simple unit-root tests and cointegration tests on new historical time-series indices for the effective krone rate since 1875. The results based on a real effective krone rate index with wholesale prices as deflators support a hypothesis of long-run relative PPP convergence. Half-lives are estimated to around 4 years in the post-1923 period and 2 years in the pre-1914 Classical Gold Standard period. The fastest mean reversions to relative PPP occurred towards the end of the Classical Gold Standard period and towards the end of the Bretton Woods period. The paper does not find support for long-run relative PPP convergence when consumer prices are used as deflators in the real effective krone rate index. This result seems consistent with a priori expectations based on theoretical considerations

A NEW ANALYSIS OF THE DETERMINANTS OF THE REAL DOLLAR-STERLING EXCHANGE RATE: 1871-1994

Nonlinear models of deviations from PPP have recently provided an important, theoretically well motivated, contribution to the PPP puzzle. In recent work the equilibrium level has been modeled either as constant or as time varying with very similar statistical fits and very different economic implications. The high persistence of both PPP deviations and the proxy variables for the equilibrium real rate might create a problem of spurious coefficient significance. This paper investigates the possibility of spurious regression within nonlinear models of PPP. Monte Carlo experiments show that standard critical values are not appropriate in such a context. To illustrate we consider the real Dollar-Sterling exchange rate over the period 1871-1994. Due to many exchange rate regime changes over the sample period we employ a Bootstrap methodology that preserves the original structure of the estimated residuals and obtain new critical values of the coefficient estimates. A nonlinear (ESTAR) process with a time varying equilibrium proxied by relative wealth and relative income per capita seems to parsimoniously fit the data. Our results provide further evidence for the nonlinear model with a shifting equilibrium and the implied speed of adjustment is found to be substantially faster than previously reported in the literature.ESTAR, Purchasing Power Parity, Bootstrapping

Purchasing Power Parity (PPP) in a Transition Economy - Cambodia: Empirical Evidence from Bilateral Exchange Rates

This study contributes to the existing literature by examining the validity of PPP hypothesis for Cambodia. The standard unit root tests (ADF and PP) and the panel unit root tests fail to support PPP hypothesis for the nine Cambodia’s trading partners. The unit root tests with structural break support the PPP hypothesis for the bilateral real exchange rates of Euro, Indonesia rupiah, Malaysia ringgit, and Singapore dollar. This finding is found to be relevant for ‘de-dollarization’ strategy in Cambodia, and in responding to recent global financial crisis (2007-2008).Cambodia; Dollarization; Exchange Rates; Purchasing Power Parity

REAL EXCHANGE RATES IN LATIN AMERICA: THE PPP HYPOTHESIS AND FRACTIONAL INTEGRATION

This paper tests for PPP in a group of seventeen Latin American (LA) countries by applying fractional integration techniques to real exchange rate series. Compared to earlier studies on these economies, this approach has the advantage of allowing for non-integer values for the degree of integration, and thus for the possibility of PPP not holding continuously but as a long-run equilibrium condition. Further, breaks in the series are endogenously determined using a procedure based on the least-squares principle. This is particularly crucial in the Latin American countries, which have been affected by several exchange rate crises and policy regime changes. The results, based on different assumptions about the underlying disturbances, are in the majority of cases inconsistent with PPP, even more so when breaks are incorporated: Argentina is the only country for which clear evidence of mean reversion is found in the model including a break, albeit only in the second subsample.Real Exchange Rates, Purchasing Power Parity, Fractional Integration, Structural Breaks

Perspectives on PPP and Long-Run Real Exchange Rates

This paper reviews the large and growing literature which tests PPP and other models of the long-run real exchange rate. We distinguish three different stages of PPP testing and focus on what has been learned from each. The most important overall lesson has been that the real exchange rate appears stationary over sufficiently long horizons. Simple, univariate random walk specifications can be rejected in favor of stationary alternatives. However, we argue that multivariate tests, which ask whether any linear combination of prices and exchange rates are stationary, have not necessarily provided meaningful rejections of nonstationarity. We also review a number of other theories of the long run real exchange rate -- including the Balassa-Samuelson hypothesis -- as well as the evidence supporting them. We argue that the persistence of real exchange rate movements can be generated by a number of sensible models and that Balassa- Samuelson effects seem important, but mainly for countries with widely disparate levels of income of growth. Finally, this paper presents new evidence testing the law of one price on 200 years of historical commodity price data for England and France, and uses a century of data from Argentina to test the possibility of sample-selection bias in tests of long-run PPP.

A new analysis of the determinants of the real dollar-sterling exchange rate: 1871-1994

Nonlinear models of deviations from PPP have recently provided an important, theoretically well motivated, contribution to the PPP puzzle. In recent work the equilibrium level has been modelled either as constant or as time varying with very similar statistical fits and very different economic implications. The high persistence of both PPP deviations and the proxy variables for the equilibrium real rate might create a problem of spurious coefficient significance. This paper investigates the possibility of spurious regression within nonlinear models of PPP. Monte Carlo experiments show that standard critical values are not appropriate in such a context. To illustrate we consider the real Dollar-Sterling exchange rate over the period 1871-1994. Due to many exchange rate regime changes over the sample period we employ a Bootstrap methodology that preserves the original structure of the estimated residuals and obtain new critical values of the coefficient estimates. A nonlinear (ESTAR) process with a time varying equilibrium proxied by relative wealth and relative income per capita seems to parsimoniously fit the data. Our results provide further evidence for the nonlinear model with a shifting equilibrium and the implied speed of adjustment is found to be substantially faster than previously reported in the literature.

Real exchange rates in latin america: The ppp hypothesis and fractional integration

This paper tests for PPP in a group of seventeen Latin American (LA) countries by applying fractional integration techniques to real exchange rate series. Compared to earlier studies on these economies, this approach has the advantage of allowing for non-integer values for the degree of integration, and thus for the possibility of PPP not holding continuously but as a long-run equilibrium condition. Further, breaks in the series are endogenously determined using a procedure based on the least-squares principle. This is particularly crucial in the Latin American countries, which have been affected by several exchange rate crises and policy regime changes. The results, based on different assumptions about the underlying disturbances, are in the majority of cases inconsistent with PPP, even more so when breaks are incorporated: Argentina is the only country for which clear evidence of mean reversion is found in the model including a break, albeit only in the second subsample

Financial Market Integration and World Economic Stabilization toward Purchasing Power Parity

Purchasing power parity (PPP) is one of the most important, but empirically controversial theories in international macroeconomics. Although many researchers believe that some variant of PPP holds in the long run, there are diverse empirical results regarding the PPP hypothesis. We examine the PPP hypothesis from an alternate point of view: We investigate the possibility of financial market integration, and world economic stabilization toward PPP, by examining the change in the persistence of PPP deviations during the last three decades. We employ a fractional integration framework, which provides a powerful tool to detect changes in the persistence for highly persistent time series. First, we test the null hypothesis of no decline in the persistence of PPP deviations. The test rejects the null at the 10% significance level for 11 out of 17 countries, thus providing strong support for financial market integration and world economic stabilization toward PPP. Second, we examine the dynamics of the persistence of PPP deviations during the last three decades through rolling-window estimation. Our results show that the persistence of PPP deviations has decreased gradually, and that many real exchange rates have experienced a sharp drop in their persistence once samples starting in the mid-1980s are used. Interestingly, this timing almost coincides with the timing of U.S./world economic stabilization reported by other studies. We also examine the relation between the persistence of PPP deviations and de facto measures of financial integration by Lane and Milesi-Ferretti (2006). We confirm that they are strongly correlated for all countries. This finding suggests that the recent promotion of financial integration is one of the main sources of the decline in the persistence of PPP deviations.fractional integration, PPP, real exchange rate, financial integration

Digging Out the PPP Hypothesis: an Integrated Empirical Coverage

We use several popular tests to test the validity of the Purchasing Power Parity (PPP) hypothesis. In particular, we analyze four classes of tests { standard univariate unit root tests, co-integration, panel unit root tests and unit root tests for nonlinear frameworks {, for a dataset consisting of 20 bilateral exchange rates. Through this approach, we ascertain the eectiveness of each methodology in assessing the validity of PPP. Overall, our results suggest little evidence to support PPP. Among the conducted tests, the panel analysis of nonstationarity idiosyncratic and common components provides the richest insights by disentangling the possible sources of non-stationarity of real exchange rates. The relevance of using price indexes with dierent characteristics is also pinpointed.PPP; Real exchange rate; Unit roots; Co-integration; Panel; Nonlinear models; Cross-sectional dependence