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Threshold Cointegration and the PPP Hypothesis

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  • Pedro Gouveia
  • Paulo Rodrigues

Abstract

Self-Exciting Threshold Autoregressive (SETAR) models are a non-linear variant of conventional linear Autoregressive (AR) models. One advantage of SETAR models over conventional AR models lies in its flexible nature in dealing with possible asymmetric behaviour of economic variables. The concept of threshold cointegration implies that the Error Correction Mechanism (ECM) at a particular interval is inactive as a result of adjustment costs, and active when deviations from equilibrium exceed certain thresholds. For instance, the presence of adjustment costs can, in many circumstances, justify the fact that economic agents intervene to recalibrate back to a tolerable limit, as in the case when the benefits of adjustment are superior to its costs. We introduce an approach that accounts for potential asymmetry and we investigate the presence of the relative version of the purchasing power parity (PPP) hypothesis for 14 countries. Based on a threshold cointegration adaptation of the unit root test procedure suggested by Caner & Hansen (2001), we find evidence of an asymmetric adjustment for the relative version of PPP for eight pairs of countries.

Suggested Citation

  • Pedro Gouveia & Paulo Rodrigues, 2004. "Threshold Cointegration and the PPP Hypothesis," Journal of Applied Statistics, Taylor & Francis Journals, vol. 31(1), pages 115-127.
  • Handle: RePEc:taf:japsta:v:31:y:2004:i:1:p:115-127 DOI: 10.1080/0266476032000148984
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    References listed on IDEAS

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    Cited by:

    1. Arnade, Carlos & Hoffman, Linwood, 2016. "Maize Price Relationships in a Changing International Market: Have Brazil and/or Ukraine Crossed a Threshold?," 2017 Allied Social Science Association (ASSA) Annual Meeting, January 6-8, 2017, Chicago, Illinois 250116, Agricultural and Applied Economics Association.
    2. repec:kap:iaecre:v:14:y:2008:i:1:p:11-24 is not listed on IDEAS
    3. Katja Funke & Isabell Koske, 2008. "Does the Law of One Price Hold within the EU? A Panel Analysis," International Advances in Economic Research, Springer;International Atlantic Economic Society, pages 11-24.
    4. Penelope Smith, 2006. "Bayesian Inference for a Threshold Autoregression with a Unit Root," Melbourne Institute Working Paper Series wp2006n20, Melbourne Institute of Applied Economic and Social Research, The University of Melbourne.
    5. Aksoy Yunus & Leon-Ledesma Miguel A., 2008. "Non-Linearities and Unit Roots in G7 Macroeconomic Variables," The B.E. Journal of Macroeconomics, De Gruyter, pages 1-44.
    6. repec:eee:jrpoli:v:52:y:2017:i:c:p:358-365 is not listed on IDEAS

    More about this item

    Keywords

    Nonlinearity; cointegration; Setar models;

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