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Parity Reversion in Real Exchange Rates

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Author Info

  • C. John McDermott
  • Paul Cashin

Abstract

Consensus estimates put the half-life of deviations from purchasing power parity (PPP) at about four years (Rogoff, 1996). However, conventional least squares estimates of half-lives are biased downward. Accordingly, as a preferred measure of the persistence of real exchange rate shocks, this study uses median-unbiased estimators of the half-life of deviations from parity, which correct for the downward bias of conventional estimators. The paper tests for PPP using real effective exchange rate data for 90 developed and developing countries in the post-Bretton Woods period. Support for PPP is found, as the majority of countries experience finite deviations of real exchange rates from parity. The speed of parity reversion is found to be typically much faster for developed countries than for developing countries, and to be considerably faster for countries with flexible nominal exchange rate regimes in comparison with countries having fixed nominal exchange rate regimes.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 04/128.

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Length: 43
Date of creation: 01 Jul 2004
Date of revision:
Handle: RePEc:imf:imfwpa:04/128

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Keywords: Purchasing power parity; Real effective exchange rates; Flexible exchange rate policy; Economic models; exchange rate; real exchange rate; exchange rates; real exchange rates; nominal exchange rate; correlation; exchange rate shocks; equation; exchange rate regimes; probability; time series; effective exchange rate; real effective exchange rate; frequency distribution; approximate p -value; exchange rate regime; exchange rate deviations; statistics; effective exchange rates; nominal exchange rates; flexible exchange rate; exchange rate data; fixed nominal exchange rate; statistic; rate of change; confidence intervals; exchange rate variability; flexible exchange rate countries; significance level; exchange arrangements; official exchange rate; sampling; standard deviation; exchange restrictions; logarithm; econometrics; exchange rate determination; parallel exchange rate; statistical significance; confidence interval; market exchange rate; bilateral exchange rates; correlations; covariance; exchange rate arrangements; exchange rate volatility; financial statistics; nominal effective exchange rate; descriptive statistics; exchange rate regime classification; exchange rate classification; least squares regression; exchange market intervention; flexible exchange rates; surveys; parallel nominal exchange rate; sample size; cointegration; real exchange rate series; currency boards; exchange rate dynamics; exchange rate shock; exchange rate behavior; exchange rate economics; bayesian analysis; prediction; bilateral real exchange rate; central tendency; flexible exchange rate regime; estimation of equation; overvaluation of real exchange rates; distributional assumption; alternative exchange rate regimes; statistical tests; real exchange rate behavior; exchange rate developments; predictions; nominal exchange rate arrangements; foreign exchange; history of exchange rate; exchange rate policy; flexible exchange rate regimes; nonparametric statistics; samples; de facto exchange rate regime; autocorrelation; alternative exchange rate; exchange rate indicators; probabilities;

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References

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Citations

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Cited by:
  1. Luis Fernando Melo Velandia & Óscar Reinaldo Becerra Camargo, 2008. "Una descripción de la dinámica de las tasas de interés de corto plazo en Colombia," Monetaria, Centro de Estudios Monetarios Latinoamericanos, vol. 0(2), pages 145-173, julio-sep.
  2. Derek Bond & Michael J. Harrison & Edward J. O'Brien, 2006. "Purchasing Power Parity: The Irish Experience Re-visited," Trinity Economics Papers tep200615, Trinity College Dublin, Department of Economics.
  3. Fernando N. de Oliveira, 2008. "Canal de crédito bancario en Brasil: evidencia de la oferta de crédito bancario y de la composición del financiamiento externo de las empresas," Monetaria, Centro de Estudios Monetarios Latinoamericanos, vol. 0(2), pages 175-220, julio-sep.
  4. Elizabeth Bucacos, 2008. "Real (effective) exchange rate in Uruguay: a periodic cointegration approach," Monetaria, Centro de Estudios Monetarios Latinoamericanos, vol. 0(2), pages 265-289, julio-sep.
  5. Hausmann, Ricardo & Panizza, Ugo & Rigobon, Roberto, 2006. "The long-run volatility puzzle of the real exchange rate," Journal of International Money and Finance, Elsevier, vol. 25(1), pages 93-124, February.
  6. Ganguly, Srideep & Breuer, Janice Boucher, 2010. "Nominal exchange rate volatility, relative price volatility, and the real exchange rate," Journal of International Money and Finance, Elsevier, vol. 29(5), pages 840-856, September.
  7. Antoine Martin & Cyril Monnet, 2008. "Marcos de implementación de la política monetaria: un análisis comparativo," Monetaria, Centro de Estudios Monetarios Latinoamericanos, vol. 0(2), pages 221-262, julio-sep.

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