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A Reappraisal of the Border Effect on Relative Price Volatility

  • Yin-Wong Cheung
  • Kon S. Lai

Engel and Rogers (1996) find that crossing the US-Canada border can considerably raise relative price volatility and that exchange rate fluctuations explain about one-third of the volatility increase. In re-evaluating the border effect, this study shows that cross-country heterogeneity in price volatility can lead to significant bias in measuring the border effect unless proper adjustment is made to correct it. The analysis explores the implication of symmetric sampling for border effect estimation. Moreover, using a direct decomposition method, two conditions governing the strength of the border effect are identified. In particular, the more dissimilar the price shocks are across countries, the greater the border effect will be. Decomposition estimates also suggest that exchange rate fluctuations actually account for a large majority of the border effect.

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File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2006/wp-cesifo-2006-01/cesifo1_wp1640.pdf
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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 1640.

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Date of creation: 2006
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Handle: RePEc:ces:ceswps:_1640
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  1. Yin-Wong Cheung & Eiji Fujii, 2005. "Cross-Country Relative Price Volatility: Effects of Market Structure," CESifo Working Paper Series 1456, CESifo Group Munich.
  2. Charles Engel & John H. Rogers, 1999. "Violating the law of one price: should we make a federal case out of it?," International Finance Discussion Papers 644, Board of Governors of the Federal Reserve System (U.S.).
  3. Engel, C., 1996. "Accounting for U.S. Real Exchange Rate Changes," Discussion Papers in Economics at the University of Washington 96-02, Department of Economics at the University of Washington.
  4. David C. Parsley & Shang-Jin Wei, 2000. "Explaining the Border Effect: The Role of Exchange Rate Variability, Shipping Costs, and Geography," NBER Working Papers 7836, National Bureau of Economic Research, Inc.
  5. Robert C. Feenstra & Jon D. Kendall, 1994. "Passthrough of Exchange Rates and Purchasing Power Parity," NBER Working Papers 4842, National Bureau of Economic Research, Inc.
  6. Charles Engel & John H. Rogers, 1995. "How wide is the border?," International Finance Discussion Papers 498, Board of Governors of the Federal Reserve System (U.S.).
  7. Engel, Charles & Rogers, John H., 2001. "Deviations from purchasing power parity: causes and welfare costs," Journal of International Economics, Elsevier, vol. 55(1), pages 29-57, October.
  8. Stephen G. Cecchetti & Nelson C. Mark & Robert J. Sonora, 2002. "Price Index Convergence Among United States Cities," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 43(4), pages 1081-1099, November.
  9. Engel, Charles, 1993. "Real exchange rates and relative prices : An empirical investigation," Journal of Monetary Economics, Elsevier, vol. 32(1), pages 35-50, August.
  10. Froot, Kenneth A & Klemperer, Paul D, 1989. "Exchange Rate Pass-Through When Market Share Matters," American Economic Review, American Economic Association, vol. 79(4), pages 637-54, September.
  11. Cheung, Yin-Wong & Chinn, Menzie & Fujii, Eiji, 2001. "Market Structure and the Persistence of Sectoral Real Exchange Rates," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 6(2), pages 95-114, April.
  12. Mario J. Crucini & Chris I. Telmer & Marios Zachariadis, 2001. "Understanding European Real Exchange Rates," Vanderbilt University Department of Economics Working Papers 0120, Vanderbilt University Department of Economics.
  13. Janet Ceglowski, 2003. "The law of one price: intranational evidence for Canada," Canadian Journal of Economics, Canadian Economics Association, vol. 36(2), pages 373-400, May.
  14. Yuriy Gorodnichenko & Linda Tesar, 2005. "A Re-Examination of the Border Effect," Working Papers 546, Research Seminar in International Economics, University of Michigan.
  15. Charles Engel & John H. Rogers, 1998. "Relative Price Volatility: What Role Does the Border Play?," Discussion Papers in Economics at the University of Washington 0061, Department of Economics at the University of Washington.
  16. Depken, Craig II & Sonora, Robert J., 2002. "International price volatility: Evidence from U.S. and Mexican cities," The North American Journal of Economics and Finance, Elsevier, vol. 13(2), pages 179-193, August.
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