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An Unbiased Appraisal of Purchasing Power Parity

Author

Listed:
  • Paul Cashin

    (International Monetary Fund)

  • C. John McDermott

    (International Monetary Fund)

Abstract

Univariate studies of the hypothesis of unit roots in real exchange rates have yielded consensus point estimates of the half-life of deviations from purchasing power parity (PPP) of between three to five years (Rogoff, 1996). However, conventional least-squares-based estimates of half-lives are biased downward. Accordingly, as a preferred measure of the persistence of real exchange rate shocks we use median-unbiased estimators of the half-life of deviations from parity, which correct for the downward bias of conventional estimators. We study this issue using real effective exchange rate (REER) data for 20 industrial countries in the post-Bretton Woods period. The serial correlation-robust median-unbiased estimator yields a cross-country average of half-lives of deviations from parity of about eight years, with the REER of several countries displaying permanent deviations from parity. However, using the median-unbiased estimator that is robust to the moving average and heteroskedastic errors present in real exchange rate data reduces the estimated half-life of parity deviations. Using this unbiased estimator, we find that the majority of countries have finite point estimates of half-lives of parity deviation, which is supportive of PPP holding in the post-Bretton Woods period. We also find that the average bias-corrected half-life of parity deviations is about five years, which is consistent with (but at the upper end of) Rogoff's (1996) consensus estimate of the half-life of deviations from parity. Copyright 2003, International Monetary Fund

Suggested Citation

  • Paul Cashin & C. John McDermott, 2003. "An Unbiased Appraisal of Purchasing Power Parity," IMF Staff Papers, Palgrave Macmillan, vol. 50(3), pages 1-1.
  • Handle: RePEc:pal:imfstp:v:50:y:2003:i:3:p:1
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    Cited by:

    1. Qian Chen & David E. Giles, 2007. "A Saddlepoint Approximation to the Distribution of the Half-Life Estimator in an Autoregressive Model: New Insights Into the PPP Puzzle," Econometrics Working Papers 0703, Department of Economics, University of Victoria.
    2. Levent, Korap, 2007. "Modeling purchasing power parity using co-integration: evidence from Turkey," MPRA Paper 19584, University Library of Munich, Germany.
    3. Fullerton Jr., Thomas M. & Fierro, Karen P. & Villalobos, Emmanuel, 2009. "Cross-border restaurant price and exchange rate interactions," The North American Journal of Economics and Finance, Elsevier, vol. 20(3), pages 281-288, December.
    4. Fallahi, Firouz & Karimi, Mohammad & Voia, Marcel-Cristian, 2016. "Persistence in world energy consumption: Evidence from subsampling confidence intervals," Energy Economics, Elsevier, vol. 57(C), pages 175-183.
    5. repec:eee:eneeco:v:65:y:2017:i:c:p:228-239 is not listed on IDEAS
    6. Cuestas, Juan Carlos & Regis, Paulo José, 2013. "Purchasing power parity in OECD countries: Nonlinear unit root tests revisited," Economic Modelling, Elsevier, vol. 32(C), pages 343-346.
    7. Aviral Tiwari & Muhammad Shahbaz, 2014. "Revisiting Purchasing Power Parity for India using threshold cointegration and nonlinear unit root test," Economic Change and Restructuring, Springer, vol. 47(2), pages 117-133, May.
    8. Shiu-Sheng Chen & Charles Engel, 2005. "Does 'Aggregation Bias' Explain The Ppp Puzzle?," Pacific Economic Review, Wiley Blackwell, vol. 10(1), pages 49-72, February.
    9. Paul Cashin & C. John McDermott, 2006. "Parity Reversion in Real Exchange Rates: Fast, Slow, or Not at All?," IMF Staff Papers, Palgrave Macmillan, vol. 53(1), pages 1-5.
    10. Joseph Kargbo, 2006. "Purchasing Power Parity and real exchange rate behaviour in Africa," Applied Financial Economics, Taylor & Francis Journals, vol. 16(1-2), pages 169-183.
    11. Levent, Korap, 2007. "Information content of exchange rate volatility: Turkish experience," MPRA Paper 19598, University Library of Munich, Germany.
    12. Jean Imbs & Haroon Mumtaz & Morten O. Ravn & Hélène Rey, 2005. "PPP Strikes Back: Aggregation And the Real Exchange Rate," The Quarterly Journal of Economics, Oxford University Press, vol. 120(1), pages 1-43.
    13. Emilio Pineda & Paul Cashin & Yan M Sun, 2009. "Assessing Exchange Rate Competitiveness in the Eastern Caribbean Currency Union," IMF Working Papers 09/78, International Monetary Fund.
    14. Irfan Civcir, 2003. "Before the Fall, Was the Turkish Lira Overvalued?," Eastern European Economics, Taylor & Francis Journals, vol. 41(2), pages 69-99, March.
    15. Alberola, Enrique & Lopez, Humberto & Serven, Luis, 2004. "Tango with the Gringo: the hard peg and real misalignment in Argentina," Policy Research Working Paper Series 3322, The World Bank.
    16. repec:eee:eneeco:v:63:y:2017:i:c:p:272-287 is not listed on IDEAS
    17. Blanco-Gonzalez, Lorenzo & Fullerton, Thomas Jr., 2006. "Borderplex menu evidence for the law of one price," Economics Letters, Elsevier, vol. 90(1), pages 28-33, January.
    18. Levent, Korap, 2007. "Analyzing CBRT's FOREX interventions using EGARCH (2001-2006)," MPRA Paper 20634, University Library of Munich, Germany.
    19. Joseph Kargbo, 2011. "Capital flows, real exchange rate misalignment and PPP tests in emerging market countries," Applied Economics, Taylor & Francis Journals, vol. 43(15), pages 1883-1897.
    20. Susan Thorp, 2004. "That Courage is not inconsistent with Caution: Foreign Currency Hedging for Superannuation Funds," Econometric Society 2004 Australasian Meetings 148, Econometric Society.
    21. Blanco-Gonzalez, Lorenzo & Fullerton, Thomas M., Jr., 2008. "La Ley del Precio Unitario en la Zona Metropolitana Fronteriza
      [The Law of One Price in the Borderplex]
      ," MPRA Paper 14687, University Library of Munich, Germany.

    More about this item

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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