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Can non‐linear real shocks explain the persistence of PPP exchange rate disequilibria?

Author

Listed:
  • Tuomas A. Peltonen
  • Adina Popescu
  • Michael Sager

Abstract

A core stylized fact of the empirical exchange rate literature is that half-life deviations of equilibrium real exchange rates from levels implied by Purchasing Power Parity (PPP) are very persistent. Empirical efforts to explain this persistence typically proceed along two distinct paths, resorting either to the presence of real shocks such as productivity differentials that drive equilibrium exchange rates away from levels implied by PPP, or the presence of non-linearities in the adjustment process around PPP. By contrast, we combine these two explanations in the context of an innovative panel estimation methodology. We conclude that both explanations are relevant to the behavior of exchange rates and that resulting half-lives are much shorter than estimated using linear PPP and more consistent with the observed volatility of nominal and real exchange rates. JEL Classification: F31, C23, L6, L7, L8, L9
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • Tuomas A. Peltonen & Adina Popescu & Michael Sager, 2011. "Can non‐linear real shocks explain the persistence of PPP exchange rate disequilibria?," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 16(3), pages 290-306, July.
    • Handle: RePEc:wly:ijfiec:v:16:y:2011:i:3:p:290-306
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    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • L6 - Industrial Organization - - Industry Studies: Manufacturing
    • L9 - Industrial Organization - - Industry Studies: Transportation and Utilities

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