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Purchasing Power Parity and the Taylor Rule

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  • Hyeongwoo Kim
  • Ippei Fujiwara
  • Bruce E. Hansen
  • Masao Ogaki

Abstract

It is well-known that there is a large degree of uncertainty around Rogoff's (1996) consensus half-life of the real exchange rate. To obtain a more efficient estimator, we develop a system method that combines the Taylor rule and a standard exchange rate model to estimate half-lives. Further, we propose a median unbiased estimator for the system method based on the generalized method of moments with nonparametric grid bootstrap confidence intervals. Applying the method to real exchange rates of 18 developed countries against the US dollar, we find that most half-life estimates from the single equation method fall in the range of 3 to 5 years with wide confidence intervals that extend to positive infinity. In contrast, the system method yields median-unbiased estimates that are typically shorter than one year with much sharper 95% confidence intervals. Our Monte Carlo simulation results are consistent with an interpretation of these results that the true half-lives are short but long half-life estimates from single equation methods are caused by the high degree of uncertainty of these methods.

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File URL: http://cama.crawford.anu.edu.au/pdf/working-papers/2013/412013.pdf
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Bibliographic Info

Paper provided by Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University in its series CAMA Working Papers with number 2013-41.

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Length: 44 pages
Date of creation: Jun 2013
Date of revision:
Handle: RePEc:een:camaaa:2013-41

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Keywords: Purchasing Power Parity; Taylor Rule; Half-Life of PPP Deviations; Median Unbiased Estimator; Grid-t Confidence Interval;

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Cited by:
  1. Kim, Hyeongwoo, 2009. "On the usefulness of the contrarian strategy across national stock markets: A grid bootstrap analysis," Journal of Empirical Finance, Elsevier, Elsevier, vol. 16(5), pages 734-744, December.
  2. Arellano, Manuel & Hansen, Lars Peter & Sentana, Enrique, 2012. "Underidentification?," Journal of Econometrics, Elsevier, Elsevier, vol. 170(2), pages 256-280.
  3. Hyeongwoo Kim & Nazif Durmaz, 2010. "Bias Correction and Out-of-Sample Forecast Accuracy," Auburn Economics Working Paper Series, Department of Economics, Auburn University auwp2010-02, Department of Economics, Auburn University.
  4. Maican, Florin G. & Sweeney, Richard J., 2006. "Real Exchange Rate Adjustment In European Transition Countries," Working Papers in Economics, University of Gothenburg, Department of Economics 202, University of Gothenburg, Department of Economics.
  5. Adriana Z. Fernandez & Evan F. Koenig & Alex Nikolsko-Rzhevskyy, 2008. "The relative performance of alternative Taylor rule specifications," Staff Papers, Federal Reserve Bank of Dallas, Federal Reserve Bank of Dallas, issue Jun.

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