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Does "Aggregation Bias" Explain the PPP Puzzle?

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Shiu-Sheng Chen
Charles Engel

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Abstract

Recently, Imbs et. al. (2002) have claimed that much of the purchasing power parity puzzle can be explained by aggregation bias'. This paper re-examines aggregation bias. First, it clarifies the meaning of aggregation bias and its applicability to the PPP puzzle. Second, the size of the bias' is shown to be much smaller than the simulations in Imbs et. al. (2002) suggest, if we rule out explosive roots in the simulations. Third, we show that the presence of non-persistent measurement error especially in the Imbs et. al. (2002) data can make price series appear less persistent than they really are. Finally, it is now standard to recognize that small-sample bias plagues estimates of speeds of convergence of PPP. After correcting small sample bias by methods proposed by Kilian (1998) and by So and Shin (1999), the half-life estimates indicate that heterogeneity and aggregation bias do not help to solve the PPP puzzle.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10304.

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Date of creation: Feb 2004
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Handle: RePEc:nbr:nberwo:10304

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F31 - International Economics - - International Finance - - - Foreign Exchange
C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models

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  1. Lutz Kilian, 1998. "Small-Sample Confidence Intervals For Impulse Response Functions," The Review of Economics and Statistics, MIT Press, vol. 80(2), pages 218-230, May. [Downloadable!] (restricted)
  2. 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. [Downloadable!] (restricted)
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  3. Mario J. Crucini & Mototsugu Shintani, 2006. "Persistence in Law-of-One-Price Deviations: Evidence from Micro-data," Levine's Bibliography 321307000000000311, UCLA Department of Economics. [Downloadable!]
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  4. Paul Cashin & C. John McDermott, 2003. "An Unbiased Appraisal of Purchasing Power Parity," IMF Staff Papers, Palgrave Macmillan Journals, vol. 50(3), pages 1. [Downloadable!] (restricted)
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  5. Christian Murray & David Papell, 2005. "The purchasing power parity puzzle is worse than you think," Empirical Economics, Springer, vol. 30(3), pages 783-790, October. [Downloadable!] (restricted)
  6. Engel, Charles, 2000. "Local-currency pricing and the choice of exchange-rate regime," European Economic Review, Elsevier, vol. 44(8), pages 1449-1472, August. [Downloadable!] (restricted)
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  7. 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. [Downloadable!] (restricted)
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  8. 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. [Downloadable!] (restricted)
  9. 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.
  10. Granger, C. W. J., 1980. "Long memory relationships and the aggregation of dynamic models," Journal of Econometrics, Elsevier, vol. 14(2), pages 227-238, October. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Frédérick Demers & Annie De Champlain, 2005. "Forecasting Core Inflation in Canada: Should We Forecast the Aggregate or the Components?," Working Papers 05-44, Bank of Canada. [Downloadable!]
  2. Paul Cashin & C. John McDermott, 2006. "Parity Reversion in Real Exchange Rates: Fast, Slow, or Not at All?," IMF Staff Papers, Palgrave Macmillan Journals, vol. 53(1), pages 5. [Downloadable!] (restricted)
    Other versions:
  3. Georgios Chortareas & George Kapetanios, 2005. "How Puzzling is the PPP Puzzle? An Alternative Half-Life Measure of convergence to PPP," Money Macro and Finance (MMF) Research Group Conference 2005 36, Money Macro and Finance Research Group. [Downloadable!]
    Other versions:
  4. Chi-Young Choi & Nelson Mark & Donggyu Sul, 2004. "Unbiased Estimation of the Half-Life to PPP Convergence in Panel Data," NBER Working Papers 10614, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  5. Balázs Égert, & László Halpern & Ronald MacDonald, 2005. "Equilibrium Exchange Rates in Transition Economies: Taking Stock of the Issues," William Davidson Institute Working Papers Series wp793, William Davidson Institute at the University of Michigan Stephen M. Ross Business School. [Downloadable!]
    Other versions:
  6. Mario J. Crucini & Mototsugu Shintani, 2002. "Persistence in Law-Of-One-Price Deviations: Evidence from Micro-Data," Working Papers 0222, Department of Economics, Vanderbilt University, revised Jul 2004. [Downloadable!]
    Other versions:
  7. Jeffrey A. Frankel & David C. Parsley & Shang-Jin Wei, 2005. "Slow Passthrough Around the World: A New Import for Developing Countries?," NBER Working Papers 11199, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  8. Ferre De Graeve & Olivier De Jonghe & Rudi Vander Vennet, 2004. "The Determinants of Pass-Through of Market Conditions to Bank Retail Interest Rates in Belgium," Research series 200405-2, National Bank of Belgium. [Downloadable!]
  9. Christian Broda & David E. Weinstein, 2008. "Understanding International Price Differences Using Barcode Data," NBER Working Papers 14017, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  10. Balázs Égert, 2007. "Real Convergence, Price Level Convergence and Inflation Differentials in Europe," Working Papers 138, Oesterreichische Nationalbank (Austrian Central Bank). [Downloadable!]
    Other versions:
  11. Berka, Martin, 2006. "Non-linear adjustment in law of one price deviations and physical characteristics of goods," MPRA Paper 8606, University Library of Munich, Germany, revised Dec 2007. [Downloadable!]
  12. Syed A. Basher & Josep Lluís Carrion-i-Silvestre, 2007. "Another Look at the Null of Stationary RealExchange Rates. Panel Data with Structural Breaks and Cross-section Dependence," IREA Working Papers 200710, University of Barcelona, Research Institute of Applied Economics, revised May 2007. [Downloadable!]
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