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Unreal exchange rates: a simulation-based approach to adjust misleading PPP estimates

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  • Pär Sjölander

Abstract

Purpose - In what seems as an infinitely ongoing debate regarding the purchasing power parity (PPP) theory, this paper seeks to question the strength of the scientific “evidence” put forward by the PPP revisionists Design/methodology/approach - In this paper, the validity of the PPP revisionists' scientific evidence supporting long-run PPP is questioned based on the replication of an influential review study that is considered by PPP revisionists to exhibit “some of the strongest evidence” in favour of the PPP theory. Findings - By simulation experiments it is demonstrated that the traditional PPP unit root tests are non-robust to the empirically identified (G)ARCH distortions. Due to (G)ARCH distortions, over-rejections for the traditional unit root tests are shown to be a problem that potentially misleads researchers to believe that long-run PPP holds under circumstances when it is in fact not valid. As a potential remedy to this problem, a new unit root test is introduced which is robust to conditional heteroscedasticity disturbances, and in contrast to traditional unit root tests, it exhibits no significant empirical support for the PPP theory. Originality/value - The study illustrates that the PPP revisionists' unit root tests cannot reliably test the PPP hypothesis in the presence of (G)ARCH distortions, due to bad power and size properties. Perhaps it is time to conclude that, based on the currently existing research, it is virtually impossible to empirically come to a credible conclusion regarding whether long-run PPP holds or not.

Suggested Citation

  • Pär Sjölander, 2007. "Unreal exchange rates: a simulation-based approach to adjust misleading PPP estimates," Journal of Economic Studies, Emerald Group Publishing, vol. 34(3), pages 256-288, August.
  • Handle: RePEc:eme:jespps:v:34:y:2007:i:3:p:256-288
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    Citations

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    Cited by:

    1. Mohsen Bahmani-Oskooee & Tsangyao Chang & Tsung-Hsien Chen & Han-Wen Tzeng, 2017. "Revisiting purchasing power parity in Eastern European countries: quantile unit root tests," Empirical Economics, Springer, vol. 52(2), pages 463-483, March.
    2. Mohsen Bahmani-Oskooee & Tsangyao Chang & Kuei-Chiu Lee, 2014. "Purchasing Power Parity in the BRICS and the MIST Countries: Sequential Panel Selection Method," Review of Economics & Finance, Better Advances Press, Canada, vol. 4, pages 1-12, Feburary.
    3. repec:kap:empiri:v:45:y:2018:i:1:d:10.1007_s10663-016-9355-1 is not listed on IDEAS
    4. Mohsen Bahmani-Oskooee & Tsangyao Chang & Tsung-Pao Wu, 2015. "Purchasing Power Parity in Transition Countries: Panel Stationary Test with Smooth and Sharp Breaks," International Journal of Financial Studies, MDPI, Open Access Journal, vol. 3(2), pages 1-9, May.
    5. Bahmani-Oskooee, Mohsen & Chang, Tsangyao & Lee, Kuei-Chiu, 2016. "Purchasing power parity in emerging markets: A panel stationary test with both sharp and smooth breaks," Economic Systems, Elsevier, vol. 40(3), pages 453-460.
    6. BAHMANI-OSKOOEE, Mohsen & Wu, Tsung-Pao, 2017. "Purchasing Power Parity in the 34 OECD Countries: Evidence from Quantile-Based Unit Root Tests with both Smooth and Sharp Breaks," MPRA Paper 81820, University Library of Munich, Germany, revised 07 Feb 2017.
    7. Bahmani-Oskooee Mohsen & Nasir ABM, 2015. "Purchasing Power Parity and the Law of One Price: Evidence from Commodity Prices in Asian Countries," Global Economy Journal, De Gruyter, vol. 15(2), pages 231-240, July.
    8. repec:gam:jsusta:v:9:y:2017:i:10:p:1890-:d:115819 is not listed on IDEAS

    More about this item

    Keywords

    Purchasing power; Exchange rates;

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