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State of the Art Unit Root Tests and the PPP Puzzle

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  • Claude Lopez

    (University of Cincinnati)

  • Christian J. Murray

    (University of Houston)

  • David H. Papell

    (University of Houston)

Abstract

Using median-unbiased estimation, recent research has questioned the validity of Rogoff’s “remarkable consensus” of 3-5 year half-lives of deviations from PPP. These estimates, however, are based on unit root tests with low power. We extend median-unbiased estimation to the efficient unit root test of Elliott, Rothenberg, and Stock (1996). We find that median-unbiased estimation based on the more powerful unit root test has the potential to tighten confidence intervals for half- lives. Using long horizon real exchange rate data, we find that the typical lower bound of the confidence intervals for median-unbiased half-lives is above 3 years. Thus, while previous confidence intervals for half-lives are consistent with virtually anything, our tighter confidence intervals now rule out economic models with nominal rigidities as candidates for explaining the observed behavior of real exchange rates. Therefore, while we obtain more information using efficient unit root tests on longer term data, this information moves us away from solving the PPP puzzle.

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File URL: http://128.118.178.162/eps/mac/papers/0310/0310009.pdf
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Bibliographic Info

Paper provided by EconWPA in its series Macroeconomics with number 0310009.

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Length: 27 pages
Date of creation: 08 Oct 2003
Date of revision:
Handle: RePEc:wpa:wuwpma:0310009

Note: Type of Document - Acrobat PDF; prepared on PC; to print on A4; pages: 27 ; figures: included
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Web page: http://128.118.178.162

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Keywords: PPP Unit root test Median-unbiased DF-GLS test;

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References

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  1. Lutz Kilian & Tao Zha, 2002. "Quantifying the uncertainty about the half-life of deviations from PPP," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 17(2), pages 107-125.
  2. 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.
  3. Cheung, Yin-Wong & Lai, Kon S., 2000. "On the purchasing power parity puzzle," Journal of International Economics, Elsevier, vol. 52(2), pages 321-330, December.
  4. Hansen,B.E., 1998. "The grid bootstrap and the autoregressive model," Working papers 26, Wisconsin Madison - Social Systems.
  5. Rossi, Barbara, 2005. "Confidence Intervals for Half-Life Deviations From Purchasing Power Parity," Journal of Business & Economic Statistics, American Statistical Association, vol. 23, pages 432-442, October.
  6. Abuaf, Niso & Jorion, Philippe, 1990. " Purchasing Power Parity in the Long Run," Journal of Finance, American Finance Association, vol. 45(1), pages 157-74, March.
  7. Engel, C., 1996. "Long-Run PPP May Not Hold After All," Discussion Papers in Economics at the University of Washington 96-05, Department of Economics at the University of Washington.
  8. Atsushi Inoue & Lutz Kilian, 2000. "Bootstrapping Autoregressive Processes with Possible Unit Roots," Econometric Society World Congress 2000 Contributed Papers 0401, Econometric Society.
  9. Diebold, Francis X & Husted, Steven & Rush, Mark, 1991. "Real Exchange Rates under the Gold Standard," Journal of Political Economy, University of Chicago Press, vol. 99(6), pages 1252-71, December.
  10. Serena Ng & Pierre Perron, 1997. "Lag Length Selection and the Construction of Unit Root Tests with Good Size and Power," Boston College Working Papers in Economics 369, Boston College Department of Economics, revised 01 Sep 2000.
  11. Glen, Jack D., 1992. "Real exchange rates in the short, medium, and long run," Journal of International Economics, Elsevier, vol. 33(1-2), pages 147-166, August.
  12. Lutz Kilian, 1999. "Finite-Sample Properties of Percentile and Percentile-t Bootstrap Confidence Intervals for Impulse Responses," The Review of Economics and Statistics, MIT Press, vol. 81(4), pages 652-660, November.
  13. Hall, Alastair R, 1994. "Testing for a Unit Root in Time Series with Pretest Data-Based Model Selection," Journal of Business & Economic Statistics, American Statistical Association, vol. 12(4), pages 461-70, October.
  14. 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.
  15. 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.
  16. Lothian, James R & Taylor, Mark P, 1996. "Real Exchange Rate Behavior: The Recent Float from the Perspective of the Past Two Centuries," Journal of Political Economy, University of Chicago Press, vol. 104(3), pages 488-509, June.
  17. 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.
  18. West, Kenneth D., 1987. "A note on the power of least squares tests for a unit root," Economics Letters, Elsevier, vol. 24(3), pages 249-252.
  19. Graham Elliott & Thomas J. Rothenberg & James H. Stock, 1992. "Efficient Tests for an Autoregressive Unit Root," NBER Technical Working Papers 0130, National Bureau of Economic Research, Inc.
  20. Cheung, Yin-Wong & Lai, Kon S., 1994. "Mean reversion in real exchange rates," Economics Letters, Elsevier, vol. 46(3), pages 251-256, November.
  21. Alan M. Taylor, 2000. "A Century of Purchasing-Power Parity," NBER Working Papers 8012, National Bureau of Economic Research, Inc.
  22. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
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