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Nonlinear Adjustment in Law of One Price Deviations and Physical Characteristics of Goods

  • Martin Berka

At a level of individual goods, heterogeneity of marginal transaction costs, proxied by price-to-weight ratios and stowage factors, explains a large part of the variation in thresholds of no-adjustment and conditional half-lives of law of one price deviations. Prices of heavier (more voluminous) goods deviate further before becoming mean-reverting. Moreover, after becoming mean-reverting, prices of heavier goods converge more slowly. Together with measures of pricing power, market size, distance, and exchange rate volatility, these factors explain up to 43% of variation in no-adjustment threshold estimates across 52 goods in US-Canada post-Bretton Woods monthly CPI data and are robust in a broader five-country dataset. They open two avenues for the importance of marginal transaction costs in accounting for real exchange rate persistence: through (a) generating persistence in individual real exchange rate components, and (b) accentuating it by the aggregation of heterogeneous components ("aggregation bias" of Imbs et al., 2005a ). Copyright © 2009 The Author. Journal compilation © Blackwell Publishing Ltd 2009.

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Article provided by Wiley Blackwell in its journal Review of International Economics.

Volume (Year): 17 (2009)
Issue (Month): 1 (02)
Pages: 51-73

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Handle: RePEc:bla:reviec:v:17:y:2009:i:1:p:51-73
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