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Confidence Intervals for Half-life Deviations from Purchasing Power Parity

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  • Rossi, Barbara

Abstract

According to the Purchasing Power Parity (PPP) theory, real exchange rate fluctuations are mainly caused by transitory shocks. The theory fits well one empirical feature of the data, namely the short-run volatility of real exchange rates, but also implies that shocks should die away in one to two years (the time interval compatible with price and wage stickiness). Existing point estimates of half-life deviations from PPP are in the order of 3 to 5 years, too big to be reconciled with the PPP. The scope of this paper is to assess how much uncertainty there is around these point estimates. We construct confidence intervals that are robust to high persistence in the presence of small sample sizes. The empirical evidence suggests that the lower bound of the confidence interval is around 4 to 6 quarters for most currencies. With a few exceptions, the results show that the data are not inconsistent with the PPP theory, although we cannot provide conclusive evidence in favor of PPP either.

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Bibliographic Info

Paper provided by Duke University, Department of Economics in its series Working Papers with number 02-08.

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Date of creation: 2002
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Handle: RePEc:duk:dukeec:02-08

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  1. Stock, James H, 1996. "VAR, Error Correction and Pretest Forecasts at Long Horizons," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 58(4), pages 685-701, November.
  2. Caner, M. & Kilian, L., 2001. "Size distortions of tests of the null hypothesis of stationarity: evidence and implications for the PPP debate," Journal of International Money and Finance, Elsevier, vol. 20(5), pages 639-657, October.
  3. Atsushi Inoue & Lutz Kilian, 2000. "Bootstrapping Autoregressive Processes with Possible Unit Roots," Econometric Society World Congress 2000 Contributed Papers 0401, Econometric Society.
  4. Claude Lopez & Christian J. Murray & David H. Papell, 2004. "State of the Art Unit Root Tests and Purchasing Power Parity," University of Cincinnati, Economics Working Papers Series 2004-04, University of Cincinnati, Department of Economics.
  5. Serena Ng & Pierre Perron, 2001. "LAG Length Selection and the Construction of Unit Root Tests with Good Size and Power," Econometrica, Econometric Society, vol. 69(6), pages 1519-1554, November.
  6. Andrews, Donald W K, 1993. "Exactly Median-Unbiased Estimation of First Order Autoregressive/Unit Root Models," Econometrica, Econometric Society, vol. 61(1), pages 139-65, January.
  7. Frankel, Jeffrey A. & Rose, Andrew K., 1996. "A panel project on purchasing power parity: Mean reversion within and between countries," Journal of International Economics, Elsevier, vol. 40(1-2), pages 209-224, February.
  8. Charles Engel, 1996. "Long-Run PPP May Not Hold After All," NBER Working Papers 5646, National Bureau of Economic Research, Inc.
  9. Murray, Christian J. & Papell, David H., 2002. "The purchasing power parity persistence paradigm," Journal of International Economics, Elsevier, vol. 56(1), pages 1-19, January.
  10. Phillips, Peter C. B., 1998. "Impulse response and forecast error variance asymptotics in nonstationary VARs," Journal of Econometrics, Elsevier, vol. 83(1-2), pages 21-56.
  11. 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, vol. 104(3), pages 488-509, June.
  12. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
  13. Graham Elliott & Elena Pesavento, 2005. "Higher Power Tests for Bilateral Failure of PPP after 1973," Emory Economics 0502, Department of Economics, Emory University (Atlanta).
  14. Nikolay Gospodinov, 2001. "Asymptotic Confidence Intervals for Impulse Responses of Near-Integrated Processes: An Application to Purchasing Power Parity," Computing in Economics and Finance 2001 136, Society for Computational Economics.
  15. Elliott, Graham & Stock, James H., 2001. "Confidence intervals for autoregressive coefficients near one," Journal of Econometrics, Elsevier, vol. 103(1-2), pages 155-181, July.
  16. Haroon Mumtaz & Jean Imbs & Morten O. Ravn & Helene Rey, 2003. "PPP Strikes Back," IMF Working Papers 03/68, International Monetary Fund.
  17. 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.
  18. Andrews, Donald W K & Chen, Hong-Yuan, 1994. "Approximately Median-Unbiased Estimation of Autoregressive Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 12(2), pages 187-204, April.
  19. Abuaf, Niso & Jorion, Philippe, 1990. " Purchasing Power Parity in the Long Run," Journal of Finance, American Finance Association, vol. 45(1), pages 157-74, March.
  20. Graham Elliott & Thomas J. Rothenberg & James H. Stock, 1992. "Efficient Tests for an Autoregressive Unit Root," NBER Technical Working Papers 0130, National Bureau of Economic Research, Inc.
  21. Lutz Kilian & Tao Zha, 2002. "Quantifying the uncertainty about the half-life of deviations from PPP," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 17(2), pages 107-125.
  22. Sims, Christopher A & Stock, James H & Watson, Mark W, 1990. "Inference in Linear Time Series Models with Some Unit Roots," Econometrica, Econometric Society, vol. 58(1), pages 113-44, January.
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