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On the Failure of Purchasing Power Parity for Bilateral Exchange Rates after 1973

  • Elliott, Graham
  • Pesavento, Elena

Point estimates suggest mean reversion in real exchange rates; however, it still remains uncomfortable that models without any mean reversion are often compatible with data from the floating period. Studies with data over longer periods find mean reversion, but at the cost of mixing in data from earlier exchange rate arrangements. Pooling the floating period data potentially mixes country pairs with and without mean reversion. We examine tests for mean reversion for individual country pairs where greater power against close alternatives is gained through modeling other economic variables with the real exchange rate. By increasing the power of the tests we find strong evidence of mean reversion.

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File URL: http://dx.doi.org/10.1353/mcb.2006.0080
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Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 38 (2006)
Issue (Month): 6 (September)
Pages: 1405-1430

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Handle: RePEc:mcb:jmoncb:v:38:y:2006:i:6:p:1405-1430
Contact details of provider: Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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  1. 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.
  2. Perron, Pierre, 1991. "Test Consistency with Varying Sampling Frequency," Econometric Theory, Cambridge University Press, vol. 7(03), pages 341-368, September.
  3. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," Journal of Political Economy, University of Chicago Press, vol. 103(3), pages 624-60, June.
  4. John H. Rogers, 1998. "Monetary shocks and real exchange rates," International Finance Discussion Papers 612, Board of Governors of the Federal Reserve System (U.S.).
  5. Ganelli, Giovanni, 2003. "The New Open Economy Macroeconomics of Government Debt," Royal Economic Society Annual Conference 2003 83, Royal Economic Society.
  6. Graham Elliott & Michael Jansson & Elena Pesavento, 2005. "Optimal Power for Testing Potential Cointegrating Vectors With Known Parameters for Nonstationarity," Journal of Business & Economic Statistics, American Statistical Association, vol. 23, pages 34-48, January.
  7. Engel, C., 1996. "Long-Run PPP May Not Hold After All," Working Papers 96-05, University of Washington, Department of Economics.
  8. Elliott, Graham & Jansson, Michael, 2002. "Testing for Unit Roots with Stationary Covariates," University of California at San Diego, Economics Working Paper Series qt4v35s2gv, Department of Economics, UC San Diego.
  9. Richard Clarida & Jordi Gali & Mark Gertler, 2002. "A Simple Framework for International Monetary Policy Analysis," NBER Working Papers 8870, National Bureau of Economic Research, Inc.
  10. Graham Elliott & Thomas J. Rothenberg & James H. Stock, 1992. "Efficient Tests for an Autoregressive Unit Root," NBER Technical Working Papers 0130, National Bureau of Economic Research, Inc.
  11. Diebold, Francis X & Husted, Steven & Rush, Mark, 1991. "Real Exchange Rates under the Gold Standard," Journal of Political Economy, University of Chicago Press, vol. 99(6), pages 1252-71, December.
  12. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, June.
  13. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
  14. 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.
  15. Jorion, Philippe & Sweeney, Richard J., 1996. "Mean reversion in real exchange rates: evidence and implications for forecasting," Journal of International Money and Finance, Elsevier, vol. 15(4), pages 535-550, August.
  16. Papell, David H., 1997. "Searching for stationarity: Purchasing power parity under the current float," Journal of International Economics, Elsevier, vol. 43(3-4), pages 313-332, November.
  17. Meese, Richard A & Rogoff, Kenneth, 1988. " Was It Real? The Exchange Rate-Interest Differential Relation over the Modern Floating-Rate Period," Journal of Finance, American Finance Association, vol. 43(4), pages 933-48, September.
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