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A Bayesian Analysis of the PPP Puzzle using an Unobserved Components Model

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Author Info

  • Richard Kleijn

    () (Econometric Institute, Erasmus University Rotterdam)

  • Herman K. van Dijk

    () (Econometric Institute, Erasmus University Rotterdam)

Abstract

The failure to describe the time series behaviour of most realexchange rates as temporary deviations from fixedlong-term means may be due to time variation of the equilibriathemselves, see Engel (2000). We implement thisidea using an unobserved components model and decompose theobservations on real exchange rates in long-termcomponents, which capture the time-variation of the mean and inmedium and short-term components whichmeasure temporary deviations. A simulation-based Bayesian analysis isintroduced to compute the posteriordistribution of (functions) of the model parameters. A stationaritytest in this setup indicates that the mean isslowly time-varying. Subsequently, we use our flexible model toderive the implied distributions of some keyfeatures of real exchange rates. Most notably, the half-life ofdeviations from the mean, which is a measure ofpersistence, is lowered. This provides a possible explanation for thePPP puzzle.

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Bibliographic Info

Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 01-105/4.

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Date of creation: 20 Nov 2001
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Handle: RePEc:dgr:uvatin:20010105

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Web page: http://www.tinbergen.nl

Related research

Keywords: purchasing power parity puzzle; real exchange rate; time-varying mean; Gibbs sampling;

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References

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  1. 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.
  2. Clark, Peter K., 1988. "Nearly redundant parameters and measures of persistence in economic time series," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 447-461.
  3. Peter C.B. Phillips, 1990. "To Criticize the Critics: An Objective Bayesian Analysis of Stochastic Trends," Cowles Foundation Discussion Papers 950, Cowles Foundation for Research in Economics, Yale University.
  4. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
  5. Sims, Christopher A., 1988. "Bayesian skepticism on unit root econometrics," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 463-474.
  6. Zivot, E., 1993. "A Bayesian Analysis of the Unit Root Hypothesis Within an Unobserved Components Model," Discussion Papers in Economics at the University of Washington 93-15, Department of Economics at the University of Washington.
  7. Kwiatkowski, Denis & Phillips, Peter C. B. & Schmidt, Peter & Shin, Yongcheol, 1992. "Testing the null hypothesis of stationarity against the alternative of a unit root : How sure are we that economic time series have a unit root?," Journal of Econometrics, Elsevier, vol. 54(1-3), pages 159-178.
  8. Zivot, Eric, 1994. "A Bayesian Analysis Of The Unit Root Hypothesis Within An Unobserved Components Model," Econometric Theory, Cambridge University Press, vol. 10(3-4), pages 552-578, August.
  9. John Geweke, 1999. "Using Simulation Methods for Bayesian Econometric Models," Computing in Economics and Finance 1999 832, Society for Computational Economics.
  10. Sims, Christopher A & Uhlig, Harald, 1991. "Understanding Unit Rooters: A Helicopter Tour," Econometrica, Econometric Society, vol. 59(6), pages 1591-99, November.
  11. repec:cup:etheor:v:10:y:1994:i:3-4:p:552-78 is not listed on IDEAS
  12. Gary Koop & Herman K. van Dijk, 1999. "Testing for Integration using Evolving Trend and Seasonals Models: A Bayesian Approach," Tinbergen Institute Discussion Papers 99-072/4, Tinbergen Institute.
  13. Siem Jan Koopman & Neil Shephard & Jurgen A. Doornik, 1999. "Statistical algorithms for models in state space using SsfPack 2.2," Econometrics Journal, Royal Economic Society, vol. 2(1), pages 107-160.
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Cited by:
  1. Georgios Chortareas & George Kapetanios, 2004. "How Puzzling is the PPP Puzzle? An Alternative Half-Life Measure of Convergence to PPP," Working Papers 522, Queen Mary, University of London, School of Economics and Finance.
  2. Eliana González & Luis F. Melo & Luis E. Rojas & Brayan Rojas, . "Estimations of the natural rate of interest in Colombia," Borradores de Economia 626, Banco de la Republica de Colombia.

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