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Uncover Latent PPP by Dynamic Factor Error Correction Model (DF-ECM) Approach: Evidence from five OECD countries

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  • Qin, Duo
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Abstract

This study explores a new modelling approach to bridge the gap between the bilateral setting of one ?domestic? economy facing one ?foreign? entity in theory and multilateral country data in reality. Under the approach, purchasing power parity (PPP) is embedded in latent disequilibrium factors, being extracted from a large set of bilateral price disparities; the factors are then used as error-correction leading indicators to explain exchange rate and inflation. Modelling experiments on five OECD countries using monthly data show promising results, which reverse the common belief that PPP is at best a very long-run relationship at the macro level. --

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Bibliographic Info

Paper provided by Kiel Institute for the World Economy in its series Economics Discussion Papers with number 2007-29.

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Date of creation: 2007
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Handle: RePEc:zbw:ifwedp:5734

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Keywords: PPP; law of one price; dynamic factor; error correction;

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Cited by:
  1. Qin, Duo & Tan, Tao, 2009. "How much intraregional exchange rate variability could a currency union remove? The case of ASEAN+3," Journal of Banking & Finance, Elsevier, vol. 33(10), pages 1793-1803, October.

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