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VECM Estimations of the PPP Reversion Rate Revisited: The Conventional Role of Relative Price Adjustment Restored

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  • Hyeongwoo Kim

Abstract

Cheung et al. (2004) use a vector error correction model that allows different speeds of convergence for nominal exchange rates and relative prices toward PPP. With the current float monthly data for five countries, they argue that the sluggish PPP reversion is primarily driven by nominal exchange rate adjustment rather than price adjustment, which is at odds with the conventional sticky-price models. Major findings of this paper are twofold. First, we show that it may be inappropriate to use short-horizon high frequency data in vector error correction models, even when both the nominal exchange rate and the relative price are not weakly exogenous. Second, using a long-horizon annual data set for 11 countries vis-?vis the US, we find a significantly important role of relative prices in real exchange rate dynamics.

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  • Hyeongwoo Kim, 2010. "VECM Estimations of the PPP Reversion Rate Revisited: The Conventional Role of Relative Price Adjustment Restored," Auburn Economics Working Paper Series auwp2010-03, Department of Economics, Auburn University.
    • Handle: RePEc:abn:wpaper:auwp2010-03
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    2. Bergin, Paul R. & Glick, Reuven & Wu, Jyh-Lin, 2014. "Mussa redux and conditional PPP," Journal of Monetary Economics, Elsevier, vol. 68(C), pages 101-114.
    3. Woo, Kai-Yin & Lee, Shu-Kam & Chan, Alan, 2014. "Non-linear adjustments to intranational PPP," Journal of Macroeconomics, Elsevier, vol. 40(C), pages 360-371.

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    More about this item

    Keywords

    Purchasing Power Parity; Convergence Rate; Half-Life; Impulse-Response; Variance Decomposition;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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