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A Cointegration Analysis of Purchasing Power Parity and Country Risk


  • Su-Yin Cheng

    (Department of Finance, National Chung Cheng University, Taiwan)

  • Jong-Shin Wei

    (Department of International Business, Wenzao Ursuline College of Languages, Taiwan)

  • Han Hou

    (Department of Finance, National Chung Cheng University, Taiwan)


This paper examines purchasing power parity (PPP) for 61 countries using the panel cointegration method developed by Westerlund (2007). After controlling for cross-sectional dependence, the results show that weak PPP is stronger for Latin American countries and for countries with moderate country risk, defined in terms of political, economic, and financial components, with direct or indirect implications for the validity of PPP. Compared with a single country characteristic that might affect PPP as suggested in the literature, country risk captures more information for explaining the validity of the PPP hypothesis.

Suggested Citation

  • Su-Yin Cheng & Jong-Shin Wei & Han Hou, 2008. "A Cointegration Analysis of Purchasing Power Parity and Country Risk," International Journal of Business and Economics, College of Business and College of Finance, Feng Chia University, Taichung, Taiwan, vol. 7(3), pages 199-211, December.
  • Handle: RePEc:ijb:journl:v:7:y:2008:i:3:p:199-211

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    References listed on IDEAS

    1. Pedroni, Peter, 2004. "Panel Cointegration: Asymptotic And Finite Sample Properties Of Pooled Time Series Tests With An Application To The Ppp Hypothesis," Econometric Theory, Cambridge University Press, vol. 20(03), pages 597-625, June.
    2. Cheung, Yin-Wong & Lai, Kon S., 2000. "On cross-country differences in the persistence of real exchange rates," Journal of International Economics, Elsevier, vol. 50(2), pages 375-397, April.
    3. M. Hashem Pesaran, 2007. "A simple panel unit root test in the presence of cross-section dependence," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 22(2), pages 265-312.
    4. Joakim Westerlund, 2007. "Testing for Error Correction in Panel Data," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 69(6), pages 709-748, December.
    5. Chang, Yoosoon, 2004. "Bootstrap unit root tests in panels with cross-sectional dependency," Journal of Econometrics, Elsevier, vol. 120(2), pages 263-293, June.
    6. Wu, Jyh-Lin & Wu, Shaowen, 2001. "Is Purchasing Power Parity Overvalued?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(3), pages 804-812, August.
    7. Cheung, Yin-Wong & Lai, Kon S., 1993. "Long-run purchasing power parity during the recent float," Journal of International Economics, Elsevier, vol. 34(1-2), pages 181-192, February.
    8. Im, Kyung So & Pesaran, M. Hashem & Shin, Yongcheol, 2003. "Testing for unit roots in heterogeneous panels," Journal of Econometrics, Elsevier, vol. 115(1), pages 53-74, July.
    9. Pippenger, Michael K., 1993. "Cointegration tests of purchasing power parity: the case of Swiss exchange rates," Journal of International Money and Finance, Elsevier, vol. 12(1), pages 46-61, February.
    10. Maddala, G S & Wu, Shaowen, 1999. " A Comparative Study of Unit Root Tests with Panel Data and a New Simple Test," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 61(0), pages 631-652, Special I.
    11. Holmes, Mark J., 2001. "New Evidence on Real Exchange Rate Stationarity and Purchasing Power Parity in Less Developed Countries," Journal of Macroeconomics, Elsevier, vol. 23(4), pages 601-614, October.
    12. MacDonald, Ronald, 1996. "Panel unit root tests and real exchange rates," Economics Letters, Elsevier, vol. 50(1), pages 7-11, January.
    13. Alba, Joseph D. & Papell, David H., 2007. "Purchasing power parity and country characteristics: Evidence from panel data tests," Journal of Development Economics, Elsevier, vol. 83(1), pages 240-251, May.
    14. Oh, Keun-Yeob, 1996. "Purchasing power parity and unit root tests using panel data," Journal of International Money and Finance, Elsevier, vol. 15(3), pages 405-418, June.
    15. 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.
    16. Oetzel, Jennifer M. & Bettis, Richard A. & Zenner, Marc, 2001. "Country risk measures: how risky are they?," Journal of World Business, Elsevier, vol. 36(2), pages 128-145, July.
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    Cited by:

    1. He, Huizhen & Chou, Ming Che & Chang, Tsangyao, 2014. "Purchasing power parity for 15 Latin American countries: Panel SURKSS test with a Fourier function," Economic Modelling, Elsevier, vol. 36(C), pages 37-43.

    More about this item


    purchasing power parity; country risk; panel cointegration; cross-sectional dependence;

    JEL classification:

    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • O57 - Economic Development, Innovation, Technological Change, and Growth - - Economywide Country Studies - - - Comparative Studies of Countries


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