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Uncover Latent PPP by Dynamic Factor Error Correction Model (DF-ECM) Approach: Evidence from Five OECD Countries

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Author Info
Qin, Duo

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Abstract

This study explores a new modelling approach that bridges the gap between multilateral country-level data and the bilateral-model based, goods-market specific purchasing power parity (PPP) hypothesis. Under this approach, PPP is embedded in latent common factors, extractable from a large set of bilateral price disparities, and tested via an error-correction model where the factors act as error-correction leading indicators for exchange rate and inflation. Significant modelling results for five OECD countries using monthly data suggest that the extant finding of insignificant PPP using similar data should be due to errors-in-variables attenuation and that its correction lies in effective construction of latent variables.

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Publisher Info
Article provided by Kiel Institute for the World Economy in its journal Economics: The Open-Access, Open-Assessment E-Journal.

Volume (Year): 2 (2008)
Issue (Month): 7 ()
Pages: 1-26
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Handle: RePEc:zbw:ifweej:7124

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Related research
Keywords: Law of one price; errors-in-variables; latent dynamic factor; error correction;

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Find related papers by JEL classification:
C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data
F31 - International Economics - - International Finance - - - Foreign Exchange
C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions

References listed on IDEAS
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  1. Menzie D. Chinn, 2005. "A Primer on Real Effective Exchange Rates: Determinants, Overvaluation, Trade Flows and Competitive Devaluation," NBER Working Papers 11521, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Jean Imbs & Haroon Mumtaz & Morten Ravn & Hélène Rey, 2005. "PPP Strikes Back: Aggregation and the Real Exchange Rate," The Quarterly Journal of Economics, MIT Press, vol. 120(1), pages 1-43, January.
    Other versions:
  3. Alexei Onatski, 2005. "Determining the number of factors from empirical distribution of eigenvalues," Discussion Papers 0405-19, Columbia University, Department of Economics. [Downloadable!]
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This page was last updated on 2009-11-13.

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