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Median-Unbiased Estimation in DF-GLS Regressions and the PPP Puzzle

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  • Lopez, C.
  • Murray, C J.
  • Papell, D H.

Abstract

Using median-unbiased estimation based on Augmented-Dickey-Fuller (ADF) regressions, recent research has questioned the validity of Rogoff's "remarkable consensus" of 3-5 year half-lives of deviations from PPP. The confidence intervals of these half-life estimates, however, are extremely wide, with lower bounds of about one year and upper bounds of infinity. We extend median-unbiased estimation to the DF-GLS regression of Elliott, Rothenberg, and Stock (1996). We find that combining median-unbiased estimation with this regression has the potential to tighten confidence intervals for the half-lives. Using long horizon real exchange rate data, we find that the typical lower bound of the confidence intervals for median-unbiased half-lives is just under 3 years. Thus, while previous confidence intervals for median-unbiased half-lives are consistent with virtually anything, our tighter confidence intervals are inconsistent with economic models with nominal rigidities as candidates for explaining the observed behavior of real exchange rates and move us away from solving the PPP puzzle.

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Bibliographic Info

Paper provided by Banque de France in its series Working papers with number 338.

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Length: 25 pages
Date of creation: 2011
Date of revision:
Handle: RePEc:bfr:banfra:338

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Keywords: PPP puzzle; median-unbiased; persistence.;

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References

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  1. Charles Engel, 1998. "Long-Run PPP May Not Hold After All," Working Papers 0050, University of Washington, Department of Economics.
  2. Alan M. Taylor, 2000. "Potential Pitfalls for the Purchasing-Power-Parity Puzzle? Sampling and Specification Biases in Mean-Reversion Tests of the Law of One Price," NBER Working Papers 7577, National Bureau of Economic Research, Inc.
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Citations

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Cited by:
  1. M. Dolores Gadea & Laura Mayoral, 2009. "Aggregation is not the solution: the PPP puzzle strikes back," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 24(6), pages 875-894.
  2. Hwa-Taek Lee & Gawon Yoon, 2013. "Does purchasing power parity hold sometimes? Regime switching in real exchange rates," Applied Economics, Taylor & Francis Journals, vol. 45(16), pages 2279-2294, June.
  3. Kanas, Angelos, 2006. "Purchasing Power Parity and Markov Regime Switching," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(6), pages 1669-1687, September.

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