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An Unbiased Appraisal of Purchasing Power Parity

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  • C. John McDermott
  • Paul Cashin

Abstract

Univariate studies of the hypothesis of unit roots in real exchange rates have yielded consensus point estimates of the half-life of deviations from purchasing power parity of between three to five years. However, least squares-based estimates of half-lives are biased downward. Accordingly, we follow Andrews (1993) and use median-unbiased estimators of the half-life of deviations from parity as a preferred measure of the persistence of real exchange rate shocks. We study this issue using real effective exchange rate (REER) data for 22 industrial countries in the post-Bretton Woods period. Three methods of bias correction are implemented, which yield cross-country averages of half-lives of deviations from parity ranging between 4 to 15 years, with the REER of several countries displaying permanent deviations from parity.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 01/196.

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Length: 35
Date of creation: 01 Dec 2001
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Handle: RePEc:imf:imfwpa:01/196

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Keywords: Purchasing power parity; exchange rate; exchange rates; confidence intervals; confidence interval; real exchange rates; real exchange rate; probability; equation; time series; correlation; exchange rate shocks; statistics; real effective exchange rate; effective exchange rate; cointegration; random walk; nominal exchange rates; sampling; heteroscedasticity; least squares regression; exchange rate behavior; financial statistics; econometrics; real exchange rate behavior; real exchange rate series; statistic; covariance; exchange rate economics; nominal exchange rate; exchange rate indicators; number of regressors; statistical tests; exchange rate dynamics; samples; bilateral real exchange rate; estimation method; central tendency; prediction; predictions; foreign exchange; estimation procedure; autocorrelation; exchange rate regimes; probabilities; exchange rate data; surveys; equations; logarithm; random walks; bilateral exchange rates;

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Cited by:
  1. Cuestas, Juan Carlos & Regis, Paulo José, 2013. "Purchasing power parity in OECD countries: Nonlinear unit root tests revisited," Economic Modelling, Elsevier, Elsevier, vol. 32(C), pages 343-346.
  2. Blanco-Gonzalez, Lorenzo & Fullerton, Thomas M., Jr., 2008. "La Ley del Precio Unitario en la Zona Metropolitana Fronteriza
    [The Law of One Price in the Borderplex]
    ," MPRA Paper 14687, University Library of Munich, Germany.
  3. Jean Imbs & Haroon Mumtaz & Morton O. Ravn & Helene Rey, 2002. "PPP Strikes Back: Aggregation and the Real Exchange Rate," NBER Working Papers 9372, National Bureau of Economic Research, Inc.
  4. C. John McDermott & Paul Cashin, 2004. "Parity Reversion in Real Exchange Rates," IMF Working Papers 04/128, International Monetary Fund.
  5. Susan Thorp, 2004. "That Courage is not inconsistent with Caution: Foreign Currency Hedging for Superannuation Funds," Econometric Society 2004 Australasian Meetings, Econometric Society 148, Econometric Society.
  6. Shiu-Sheng Chen & Charles Engel, 2005. "Does 'Aggregation Bias' Explain The Ppp Puzzle?," Pacific Economic Review, Wiley Blackwell, Wiley Blackwell, vol. 10(1), pages 49-72, 02.
  7. Levent, Korap, 2007. "Information content of exchange rate volatility: Turkish experience," MPRA Paper 19598, University Library of Munich, Germany.
  8. Alberola, Enrique & Lopez, Humberto & Serven, Luis, 2004. "Tango with the Gringo: the hard peg and real misalignment in Argentina," Policy Research Working Paper Series 3322, The World Bank.
  9. Aviral Tiwari & Muhammad Shahbaz, 2014. "Revisiting Purchasing Power Parity for India using threshold cointegration and nonlinear unit root test," Economic Change and Restructuring, Springer, Springer, vol. 47(2), pages 117-133, May.
  10. Fullerton Jr., Thomas M. & Fierro, Karen P. & Villalobos, Emmanuel, 2009. "Cross-border restaurant price and exchange rate interactions," The North American Journal of Economics and Finance, Elsevier, Elsevier, vol. 20(3), pages 281-288, December.
  11. Qian Chen & David E. Giles, 2007. "A Saddlepoint Approximation to the Distribution of the Half-Life Estimator in an Autoregressive Model: New Insights Into the PPP Puzzle," Econometrics Working Papers, Department of Economics, University of Victoria 0703, Department of Economics, University of Victoria.
  12. Blanco-Gonzalez, Lorenzo & Fullerton, Thomas Jr., 2006. "Borderplex menu evidence for the law of one price," Economics Letters, Elsevier, Elsevier, vol. 90(1), pages 28-33, January.
  13. Emilio Pineda & Paul Cashin & Yan Sun, 2009. "Assessing Exchange Rate Competitiveness in the Eastern Caribbean Currency Union," IMF Working Papers 09/78, International Monetary Fund.
  14. Levent, Korap, 2007. "Modeling purchasing power parity using co-integration: evidence from Turkey," MPRA Paper 19584, University Library of Munich, Germany.
  15. Levent, Korap, 2007. "Analyzing CBRT's FOREX interventions using EGARCH (2001-2006)," MPRA Paper 20634, University Library of Munich, Germany.

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