Getting PPP Right: Identifying Mean-Reverting Real Exchange Rates in Panels
AbstractRecent advances in testing for the validity of Purchasing Power Parity (PPP) focus on the time series properties of real exchange rates in panel frameworks. One weakness of such tests, however, is that they fail to inform the researcher as to which cross-section units are stationary. As a consequence, a reservation for PPP analyses based on such tests is that a small number of real exchange rates in a given panel may drive the results. In this paper we examine the PPP hypothesis focusing on the stationarity of the real exchange rates in up to 25 OECD countries. We introduce a methodology that when applied to a set of established panel-unit-root tests, allows the identification of the real exchange rates that are stationary. We apply procedures that account for cross-sectional dependence. Our results reveal evidence of mean-reversion that is significantly stronger as compared to that obtained by the existing literature, strengthening the case for PPP. Moreover, our approach can be used to provide half-lives estimates for the mean-reverting real exchange rates. We find that the half-lives are shorter than the literature consensus and therefore that the PPP puzzle is less pronounced than initially thought.
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Bibliographic InfoPaper provided by Queen Mary, University of London, School of Economics and Finance in its series Working Papers with number 629.
Date of creation: Jul 2008
Date of revision:
Note: This is a revised version of Working Paper 517.
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PPP; Panel unit root tests; Real exchange rates; Half-lives; PPP puzzle;
Find related papers by JEL classification:
- C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
- C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
- C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
- F31 - International Economics - - International Finance - - - Foreign Exchange
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-07-14 (All new papers)
- NEP-CBA-2008-07-14 (Central Banking)
- NEP-ECM-2008-07-14 (Econometrics)
- NEP-IFN-2008-07-14 (International Finance)
- NEP-OPM-2008-07-14 (Open Economy Macroeconomic)
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.:
- 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.
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- MacDonald, Ronald, 1996. "Panel unit root tests and real exchange rates," Economics Letters, Elsevier, vol. 50(1), pages 7-11, January.
- Serletis, Apostolos & Gogas, Periklis, 2004. "Long-horizon regression tests of the theory of purchasing power parity," Journal of Banking & Finance, Elsevier, vol. 28(8), pages 1961-1985, August.
- 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.
- repec:ebl:ecbull:v:3:y:2008:i:26:p:1-11 is not listed on IDEAS
- Moon, H.R. & Perron, B., 2012. "Beyond panel unit root tests: Using multiple testing to determine the nonstationarity properties of individual series in a panel," Journal of Econometrics, Elsevier, vol. 169(1), pages 29-33.
- Vasudeva N. R. Murthy & Emmanuel Anoruo, 2009. "Are Per Capita Real GDP Series in African Countries Non-stationary or Non-linear? What does Empirical Evidence Reveal?," Economics Bulletin, AccessEcon, vol. 29(4), pages 2492-2504.
- Peltonen, Tuomas A. & Sager, Michael, 2009. "Productivity shocks and real exchange rate: a reappraisal," Working Paper Series 1046, European Central Bank.
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