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Non-normality, heteroscedasticity and recursive unit root tests of PPP: solving the PPP puzzle?

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  • Guglielmo Maria Caporale
  • Andros Gregoriou

Abstract

In this article, we carry out unit root tests on real exchange rates recursively as in Caporale et al. (2003), but, following Arghyrou and Gregoriou (2007), we adjust the residuals for non-normality and heteroscedasticity using a wild bootstrap method. The results are striking: this correction sharply increases the rejection percentages of the unit root null and attenuates the erratic behaviour of the t-statistic, providing evidence in favour of purchasing power parity (PPP) and suggesting that such a correction might at least go some way towards solving the 'PPP puzzle'.

Suggested Citation

  • Guglielmo Maria Caporale & Andros Gregoriou, 2009. "Non-normality, heteroscedasticity and recursive unit root tests of PPP: solving the PPP puzzle?," Applied Economics Letters, Taylor & Francis Journals, vol. 16(3), pages 223-226.
    • Handle: RePEc:taf:apeclt:v:16:y:2009:i:3:p:223-226
    DOI: 10.1080/17446540802167321
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    References listed on IDEAS

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    1. Taylor, Mark P & Peel, David A & Sarno, Lucio, 2001. "Nonlinear Mean-Reversion in Real Exchange Rates: Toward a Solution to the Purchasing Power Parity Puzzles," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 42(4), pages 1015-1042, November.
    2. Goncalves, Silvia & Kilian, Lutz, 2004. "Bootstrapping autoregressions with conditional heteroskedasticity of unknown form," Journal of Econometrics, Elsevier, vol. 123(1), pages 89-120, November.
    3. Alan M. Taylor & Mark P. Taylor, 2004. "The Purchasing Power Parity Debate," Journal of Economic Perspectives, American Economic Association, vol. 18(4), pages 135-158, Fall.
    4. Guglielmo Maria Caporale & Mario Cerrato, 2004. "Panel Data Tests Of Ppp: A Critical Overview," Economics and Finance Discussion Papers 04-18, Economics and Finance Section, School of Social Sciences, Brunel University.
    5. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-838, May.
    6. Caporale, Guglielmo Maria & Pittis, Nikitas, 2002. "Unit Roots versus Other Types of Time Heterogeneity, Parameter Time Dependence and Superexogeneity," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 21(3), pages 207-223, April.
    7. Alan M. Taylor & Mark P. Taylor, 2004. "The Purchasing Power Parity Debate," Journal of Economic Perspectives, American Economic Association, vol. 18(4), pages 135-158, Fall.
    8. Arghyrou, Michael G. & Gregoriou, Andros, 2007. "Testing for Purchasing Power Parity correcting for non-normality using the wild bootstrap," Economics Letters, Elsevier, vol. 95(2), pages 285-290, May.
    9. Ioannidis, C. & Peel, D.A., 2005. "Testing for market efficiency in gambling markets when the errors are non-normal and heteroskedastic an application of the wild bootstrap," Economics Letters, Elsevier, vol. 87(2), pages 221-226, May.
    10. Caporale, Guglielmo Maria & Pittis, Nikitas & Sakellis, Panayiotis, 2003. "Testing for PPP: the erratic behaviour of unit root tests," Economics Letters, Elsevier, vol. 80(2), pages 277-284, August.
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