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An Unbiased Appraisal of Purchasing Power Parity

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  • Paul Cashin

    (International Monetary Fund)

  • C. John McDermott

    (International Monetary Fund)

Abstract

Univariate studies of the hypothesis of unit roots in real exchange rates have yielded consensus point estimates of the half-life of deviations from purchasing power parity (PPP) of between three to five years (Rogoff, 1996). However, conventional least-squares-based estimates of half-lives are biased downward. Accordingly, as a preferred measure of the persistence of real exchange rate shocks we use median-unbiased estimators of the half-life of deviations from parity, which correct for the downward bias of conventional estimators. We study this issue using real effective exchange rate (REER) data for 20 industrial countries in the post-Bretton Woods period. The serial correlation-robust median-unbiased estimator yields a cross-country average of half-lives of deviations from parity of about eight years, with the REER of several countries displaying permanent deviations from parity. However, using the median-unbiased estimator that is robust to the moving average and heteroskedastic errors present in real exchange rate data reduces the estimated half-life of parity deviations. Using this unbiased estimator, we find that the majority of countries have finite point estimates of half-lives of parity deviation, which is supportive of PPP holding in the post-Bretton Woods period. We also find that the average bias-corrected half-life of parity deviations is about five years, which is consistent with (but at the upper end of) Rogoff's (1996) consensus estimate of the half-life of deviations from parity. Copyright 2003, International Monetary Fund

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Bibliographic Info

Article provided by Palgrave Macmillan in its journal IMF Staff Papers.

Volume (Year): 50 (2003)
Issue (Month): 3 ()
Pages: 1

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Handle: RePEc:pal:imfstp:v:50:y:2003:i:3:p:1

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Cited by:
  1. Aviral Tiwari & Muhammad Shahbaz, 2014. "Revisiting Purchasing Power Parity for India using threshold cointegration and nonlinear unit root test," Economic Change and Restructuring, Springer, Springer, vol. 47(2), pages 117-133, May.
  2. Imbs, Jean & Mumtaz, Haroon & Ravn, Morten O. & Rey, Hélène, 2003. "PPP Strikes Back: Aggregation and the Real Exchange Rate," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3715, C.E.P.R. Discussion Papers.
  3. Shiu-Sheng Chen & Charles Engel, 2005. "Does 'Aggregation Bias' Explain The Ppp Puzzle?," Pacific Economic Review, Wiley Blackwell, Wiley Blackwell, vol. 10(1), pages 49-72, 02.
  4. Juan Carlos Cuestas & Paulo José Regis, 2010. "Purchasing power parity in OECD countries: nonlinear unit root tests revisited," Working Papers, Nottingham Trent University, Nottingham Business School, Economics Division 2010/3, Nottingham Trent University, Nottingham Business School, Economics Division.
  5. Levent, Korap, 2007. "Modeling purchasing power parity using co-integration: evidence from Turkey," MPRA Paper 19584, University Library of Munich, Germany.
  6. Susan Thorp, 2004. "That Courage is not inconsistent with Caution: Foreign Currency Hedging for Superannuation Funds," Econometric Society 2004 Australasian Meetings, Econometric Society 148, Econometric Society.
  7. Levent, Korap, 2007. "Analyzing CBRT's FOREX interventions using EGARCH (2001-2006)," MPRA Paper 20634, University Library of Munich, Germany.
  8. Levent, Korap, 2007. "Information content of exchange rate volatility: Turkish experience," MPRA Paper 19598, University Library of Munich, Germany.
  9. C. John McDermott & Paul Cashin, 2004. "Parity Reversion in Real Exchange Rates," IMF Working Papers, International Monetary Fund 04/128, International Monetary Fund.
  10. Fullerton Jr., Thomas M. & Fierro, Karen P. & Villalobos, Emmanuel, 2009. "Cross-border restaurant price and exchange rate interactions," The North American Journal of Economics and Finance, Elsevier, Elsevier, vol. 20(3), pages 281-288, December.
  11. Qian Chen & David E. Giles, 2007. "A Saddlepoint Approximation to the Distribution of the Half-Life Estimator in an Autoregressive Model: New Insights Into the PPP Puzzle," Econometrics Working Papers, Department of Economics, University of Victoria 0703, Department of Economics, University of Victoria.
  12. Enrique Alberola & Humberto López & Luis Servén, 2004. "Tango with the gringo: the hard peg and real misalign ment in Argentina," Banco de Espa�a Working Papers, Banco de Espa�a 0405, Banco de Espa�a.
  13. Blanco-Gonzalez, Lorenzo & Fullerton, Thomas M., Jr., 2008. "La Ley del Precio Unitario en la Zona Metropolitana Fronteriza
    [The Law of One Price in the Borderplex]
    ," MPRA Paper 14687, University Library of Munich, Germany.
  14. Blanco-Gonzalez, Lorenzo & Fullerton, Thomas Jr., 2006. "Borderplex menu evidence for the law of one price," Economics Letters, Elsevier, Elsevier, vol. 90(1), pages 28-33, January.
  15. Emilio Pineda & Paul Cashin & Yan Sun, 2009. "Assessing Exchange Rate Competitiveness in the Eastern Caribbean Currency Union," IMF Working Papers, International Monetary Fund 09/78, International Monetary Fund.

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