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Purchasing Power Parity Hypothesis in OIC Countries: Evidence from Panel Unit Root Tests with Heterogeneous Structural Breaks

  • Zahra (Mila) Elmi

    (Assistant Professor; Department of Economics, Mazandaran University)

  • Omid Ranjbar

    (Expert of Economic Studies - Iran Ministry of Commerce)

Purchasing power parity hypothesis is viewed as one of the central doctrines in international economics. The hypothesis states an equilibrium condition equating the nominal exchange rate between two national currencies with the relative price of an identical basket of traded goods in each country. Empirical analysis has produced mixed results in testing for the PPP. This paper analyzes the empirical validity of PPP hypothesis in OIC countries. Hence, it examines the stationarity of real exchange rate by ADF unit root test and various panel unit root tests. Using univariate ADF unit-root test on single time series and also the conventional panel unit root tests namely, Im, Pesaran, and Shin (2003), Levin, Lin & Chu (2002), and Hadri (2000), it was found that the real exchange rate of all OIC countries and also panel series of real exchange rate have unit root. But when recently developed panel LM unit root test that allow for heterogeneous level shifts, are applied, the null unit roots isn’t rejected in real exchange rates series. Our findings are generally supportive of the PPP hypothesis with the crises leading to shifts in long-run trends.

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Article provided by Economics faculty of Tehran university in its journal Iranian Economic Review.

Volume (Year): 15 (2010)
Issue (Month): 3 (fall)
Pages: 1-12

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Handle: RePEc:eut:journl:v:15:y:2010:i:3:p:1
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  1. Eric Zivot & Donald W.K. Andrews, 1990. "Further Evidence on the Great Crash, the Oil Price Shock, and the Unit Root Hypothesis," Cowles Foundation Discussion Papers 944, Cowles Foundation for Research in Economics, Yale University.
  2. Pasaran, M.H. & Im, K.S. & Shin, Y., 1995. "Testing for Unit Roots in Heterogeneous Panels," Cambridge Working Papers in Economics 9526, Faculty of Economics, University of Cambridge.
  3. Narayan Paresh K & Prasad Biman Chand, 2005. "The Validity of Purchasing Power Parity Hypothesis for Eleven Middle Eastern Countries," Review of Middle East Economics and Finance, De Gruyter, vol. 3(2), pages 44-58, August.
  4. Jeffrey A. Frankel & Andrew K. Rose, 1995. "A Panel Project on Purchasing Power Parity: Mean Reversion Within and Between Countries," NBER Working Papers 5006, National Bureau of Economic Research, Inc.
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  7. Kyung-So Im & Junsoo Lee & Margie Tieslau, 2005. "Panel LM Unit-root Tests with Level Shifts," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 67(3), pages 393-419, 06.
  8. Bahmani-Oskooee, Mohsen, 1993. "Purchasing power parity based on effective exchange rate and cointegration: 25 LDCs' experience with its absolute formulation," World Development, Elsevier, vol. 21(6), pages 1023-1031, June.
  9. Sarno, Lucio & Taylor, Mark P, 1997. "The Behaviour of Real Exchange Rates During the Post-Bretton Woods Period," CEPR Discussion Papers 1730, C.E.P.R. Discussion Papers.
  10. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
  11. Levin, Andrew & Lin, Chien-Fu & James Chu, Chia-Shang, 2002. "Unit root tests in panel data: asymptotic and finite-sample properties," Journal of Econometrics, Elsevier, vol. 108(1), pages 1-24, May.
  12. Claude Lopez & David H. Papell, 2007. "Convergence to Purchasing Power Parity at the Commencement of the Euro," Review of International Economics, Wiley Blackwell, vol. 15(1), pages 1-16, 02.
  13. Jewell, Todd & Lee, Junsoo & Tieslau, Margie & Strazicich, Mark C., 2003. "Stationarity of health expenditures and GDP: evidence from panel unit root tests with heterogeneous structural breaks," Journal of Health Economics, Elsevier, vol. 22(2), pages 313-323, March.
  14. Rudiger Dornbusch & Paul Krugman, 1976. "Felxible Exchange Rates in the Short Run," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 7(3), pages 537-584.
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