Advanced Search
MyIDEAS: Login to save this paper or follow this series

Non-Linear Dynamics in Deviations from the Law of One Price: A Broad-Based Empirical Study

Contents:

Author Info

  • Chowdhury, Ibrahim
  • Sarno, Lucio
  • Taylor, Mark P

Abstract

In this Paper we test empirically the validity of the law of one price using data for five major bilateral US dollar exchange rates and nine goods sectors during the recent floating exchange rate regime since the early 1970s. Using threshold autoregressive models, we find strong evidence of non-linear mean reversion in deviations from the law of one price with plausible convergence speeds. Consistent with theoretical arguments on international goods markets arbitrage under transactions costs and with an emerging strand of empirical literature, these results contribute towards forming a consensus view in favour of discrete regime switching in deviations from the law of one price and the presence of differing non-zero transactions costs across a broad range of goods and countries.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.cepr.org/pubs/dps/DP3377.asp
Download Restriction: CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3377.

as in new window
Length:
Date of creation: May 2002
Date of revision:
Handle: RePEc:cpr:ceprdp:3377

Contact details of provider:
Postal: Centre for Economic Policy Research, 77 Bastwick Street, London EC1V 3PZ.
Phone: 44 - 20 - 7183 8801
Fax: 44 - 20 - 7183 8820

Order Information:
Email:

Related research

Keywords: law of one price; mean reversion; purchasing power parity; real exchange rate; threshold non-linearity;

Other versions of this item:

Find related papers by JEL classification:

This paper has been announced in the following NEP Reports:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Feenstra, R.C. & Kendall, J.D., 1994. "Pass-Through of Exchange Rates and Purchasing Power Parity," Papers, Tasmania - Department of Economics 1994-06, Tasmania - Department of Economics.
  2. Lucio Sarno, 2000. "Systematic sampling and real exchange rates," Review of World Economics (Weltwirtschaftliches Archiv), Springer, Springer, vol. 136(1), pages 24-57, March.
  3. Cheung, Yin-Wong & Lai, Kon S., 2000. "On cross-country differences in the persistence of real exchange rates," Journal of International Economics, Elsevier, vol. 50(2), pages 375-397, April.
  4. Lothian, James R., 1997. "Multi-country evidence on the behavior of purchasing power parity under the current float," Journal of International Money and Finance, Elsevier, Elsevier, vol. 16(1), pages 19-35, February.
  5. Maurice Obstfeld & Kenneth Rogoff, 2000. "The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?," NBER Working Papers 7777, National Bureau of Economic Research, Inc.
  6. Engel, Charles, 1993. "Real exchange rates and relative prices : An empirical investigation," Journal of Monetary Economics, Elsevier, Elsevier, vol. 32(1), pages 35-50, August.
  7. Hansen Bruce E., 1997. "Inference in TAR Models," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 2(1), pages 1-16, April.
  8. Kenneth A. Froot & Kenneth Rogoff, 1994. "Perspectives on PPP and Long-Run Real Exchange Rates," NBER Working Papers 4952, National Bureau of Economic Research, Inc.
  9. Parsley, David C & Wei, Shang-Jin, 1996. "Convergence to the Law of One Price without Trade Barriers or Currency Fluctuations," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 111(4), pages 1211-36, November.
  10. Engel, Charles & Rogers, John H, 1996. "How Wide Is the Border?," American Economic Review, American Economic Association, vol. 86(5), pages 1112-25, December.
  11. Froot, Kenneth A. & Kim, Michael & Rogoff, Kenneth, 1995. "The Law of One Price Over 700 Years," Working Papers, C.V. Starr Center for Applied Economics, New York University 95-13, C.V. Starr Center for Applied Economics, New York University.
  12. Andrews, Donald W K & Ploberger, Werner, 1994. "Optimal Tests When a Nuisance Parameter Is Present Only under the Alternative," Econometrica, Econometric Society, Econometric Society, vol. 62(6), pages 1383-1414, November.
  13. Knetter, Michael M, 1993. "International Comparisons of Price-to-Market Behavior," American Economic Review, American Economic Association, vol. 83(3), pages 473-86, June.
  14. Clive Granger & Tae-Hwy Lee, 1999. "The effect of aggregation on nonlinearity," Econometric Reviews, Taylor & Francis Journals, Taylor & Francis Journals, vol. 18(3), pages 259-269.
  15. Obstfeld, Maurice & Taylor, Alan M., 1997. "Nonlinear Aspects of Goods-Market Arbitrage and Adjustment: Heckscher's Commodity Points Revisited," Journal of the Japanese and International Economies, Elsevier, vol. 11(4), pages 441-479, December.
  16. Paul R. Bergin & Robert C. Feenstra, 1999. "Pricing to Market, Staggered Contracts, and Real Exchange Rate Persistence," NBER Working Papers 7026, National Bureau of Economic Research, Inc.
  17. Pippenger, Michael K & Goering, Gregory E, 1993. "A Note on the Empirical Power of Unit Root Tests under Threshold Processes," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 55(4), pages 473-81, November.
  18. Feenstra, R.C., 1995. "Exact Hedonic Price Indexes," Department of Economics, California Davis - Department of Economics 95-11, California Davis - Department of Economics.
  19. Cheung, Yin-Wong & Chinn, Menzie & Fujii, Eiji, 2001. "Market Structure and the Persistence of Sectoral Real Exchange Rates," International Journal of Finance & Economics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 6(2), pages 95-114, April.
  20. Tjøstheim, Dag, 1986. "Estimation in nonlinear time series models," Stochastic Processes and their Applications, Elsevier, Elsevier, vol. 21(2), pages 251-273, February.
  21. Hansen, Bruce E, 1996. "Inference When a Nuisance Parameter Is Not Identified under the Null Hypothesis," Econometrica, Econometric Society, Econometric Society, vol. 64(2), pages 413-30, March.
  22. Balke, Nathan S & Fomby, Thomas B, 1997. "Threshold Cointegration," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 38(3), pages 627-45, August.
  23. Lothian, James R & Taylor, Mark P, 1996. "Real Exchange Rate Behavior: The Recent Float from the Perspective of the Past Two Centuries," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 104(3), pages 488-509, June.
  24. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
  25. Michael, Panos & Nobay, A Robert & Peel, David, 1994. "Purchasing power parity yet again: evidence from spatially separated commodity markets," Journal of International Money and Finance, Elsevier, Elsevier, vol. 13(6), pages 637-657, December.
  26. Dixit, Avinash K, 1989. "Hysteresis, Import Penetration, and Exchange Rate Pass-Through," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 104(2), pages 205-28, May.
  27. Cheung, Yin-Wong & Lai, Kon S, 1993. "A Fractional Cointegration Analysis of Purchasing Power Parity," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 11(1), pages 103-12, January.
  28. Knetter, Michael M, 1994. "Did the Strong Dollar Increase Competition in U.S. Product Markets?," The Review of Economics and Statistics, MIT Press, vol. 76(1), pages 192-95, February.
  29. Isard, Peter, 1977. "How Far Can We Push the "Law of One Price"?," American Economic Review, American Economic Association, vol. 67(5), pages 942-48, December.
  30. Hali J. Edison & Joseph E. Gagnon & William R. Melick, 1994. "Understanding the empirical literature on purchasing power parity: the post-Bretton Woods era," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 465, Board of Governors of the Federal Reserve System (U.S.).
  31. Knetter, Michael M, 1989. "Price Discrimination by U.S. and German Exporters," American Economic Review, American Economic Association, vol. 79(1), pages 198-210, March.
  32. Michael, Panos & Nobay, A Robert & Peel, David A, 1997. "Transactions Costs and Nonlinear Adjustment in Real Exchange Rates: An Empirical Investigation," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 105(4), pages 862-79, August.
  33. Hendry, David F., 1984. "Monte carlo experimentation in econometrics," Handbook of Econometrics, Elsevier, in: Z. Griliches† & M. D. Intriligator (ed.), Handbook of Econometrics, edition 1, volume 2, chapter 16, pages 937-976 Elsevier.
  34. Benninga, Simon & Protopapadakis, Aris, 1988. "The equilibrium pricing of exchange rates and assets when trade takes time," Journal of International Money and Finance, Elsevier, Elsevier, vol. 7(2), pages 129-149, June.
  35. Taylor, Alan M, 2001. "Potential Pitfalls for the Purchasing-Power-Parity Puzzle? Sampling and Specification Biases in Mean-Reversion Tests of the Law of One Price," Econometrica, Econometric Society, Econometric Society, vol. 69(2), pages 473-98, March.
  36. Dumas, Bernard, 1992. "Dynamic Equilibrium and the Real Exchange Rate in a Spatially Separated World," Review of Financial Studies, Society for Financial Studies, vol. 5(2), pages 153-80.
  37. O'Connell, P. G. J., 1998. "Market frictions and real exchange rates1," Journal of International Money and Finance, Elsevier, Elsevier, vol. 17(1), pages 71-95, February.
  38. Coakley, Jerry & Fuertes, Ana Maria, 1997. "New panel unit root tests of PPP," Economics Letters, Elsevier, vol. 57(1), pages 17-22, November.
  39. Cheung, Yin-Wong & Lai, Kon S., 1993. "Long-run purchasing power parity during the recent float," Journal of International Economics, Elsevier, vol. 34(1-2), pages 181-192, February.
  40. Richardson, J. David, 1978. "Some empirical evidence on commodity arbitrage and the law of one price," Journal of International Economics, Elsevier, vol. 8(2), pages 341-351, May.
  41. Cheung, Yin-Wong & Lai, Kon S., 2000. "On the purchasing power parity puzzle," Journal of International Economics, Elsevier, vol. 52(2), pages 321-330, December.
  42. Taylor, Mark P & Peel, David A & Sarno, Lucio, 2001. "Nonlinear Mean-Reversion in Real Exchange Rates: Toward a Solution to the Purchasing Power Parity Puzzles," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 42(4), pages 1015-42, November.
  43. Betts, Caroline & Devereux, Michael B., 2000. "Exchange rate dynamics in a model of pricing-to-market," Journal of International Economics, Elsevier, vol. 50(1), pages 215-244, February.
  44. Sarno, Lucio, 2000. "Real exchange rate behavior in the Middle East: a re-examination," Economics Letters, Elsevier, vol. 66(2), pages 127-136, February.
  45. Giovannini, Alberto, 1988. "Exchange rates and traded goods prices," Journal of International Economics, Elsevier, vol. 24(1-2), pages 45-68, February.
  46. O'Connell, Paul G. J. & Wei, Shang-Jin, 2002. ""The bigger they are, the harder they fall": Retail price differences across U.S. cities," Journal of International Economics, Elsevier, vol. 56(1), pages 21-53, January.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
This item has more than 25 citations. To prevent cluttering this page, these citations are listed on a separate page.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:cpr:ceprdp:3377. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.