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Higher Power Tests for Bilateral Failure of PPP after 1973

  • Graham Elliott
  • Elena Pesavento

Whilst point estimates for mean reversion in real exchange rates suggest reasonable (but long) half lives to shocks, it still remains uncomfortable that models without any mean reversion at all are often compatible with individual country pair data from the floating period. Studies with data over longer periods find mean reversion, but at the cost of mixing in data from earlier exchange rate arrangements. Pooling the floating period data for a number of countries also finds evidence of mean reversion, but at the expense of potentially mixing in country pairs with and without mean reversion. We examine tests for mean reversion for individual country pairs where greater power against close alternatives is gained through modeling other economic variables with the real exchange rate. Our results are broadly consistent with other methods to improve the power of tests for unit roots in real exchange rates, finding support for the mean reversion hypothesis.

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Paper provided by Department of Economics, Emory University (Atlanta) in its series Emory Economics with number 0502.

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Date of creation: Jan 2005
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Handle: RePEc:emo:wp2003:0502
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  1. Kenneth A. Froot & Kenneth Rogoff, 1994. "Perspectives on PPP and Long-Run Real Exchange Rates," NBER Working Papers 4952, National Bureau of Economic Research, Inc.
  2. Diebold, Francis X & Husted, Steven & Rush, Mark, 1991. "Real Exchange Rates under the Gold Standard," Journal of Political Economy, University of Chicago Press, vol. 99(6), pages 1252-71, December.
  3. Elliott, Graham & Jansson, Michael, 2000. "Testing for Unit Roots with Stationary Covariances," University of California at San Diego, Economics Working Paper Series qt47k7z69n, Department of Economics, UC San Diego.
  4. Kenneth A. Froot & Kenneth Rogoff, 1991. "The EMS, the EMU, and the Transition to a Common Currency," NBER Working Papers 3684, National Bureau of Economic Research, Inc.
  5. Engel, C., 1996. "Long-Run PPP May Not Hold After All," Discussion Papers in Economics at the University of Washington 96-05, Department of Economics at the University of Washington.
  6. Bruce E. Hansen, 1995. "Rethinking the Univariate Approach to Unit Root Testing: Using Covariates to Increase Power," Boston College Working Papers in Economics 300., Boston College Department of Economics.
  7. Jorion, Philippe & Sweeney, Richard J., 1996. "Mean reversion in real exchange rates: evidence and implications for forecasting," Journal of International Money and Finance, Elsevier, vol. 15(4), pages 535-550, August.
  8. Pippenger, Michael K & Goering, Gregory E, 1993. "A Note on the Empirical Power of Unit Root Tests under Threshold Processes," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 55(4), pages 473-81, November.
  9. Martin Eichenbaum & Charles Evans, 1992. "Some empirical evidence on the effects of monetary policy shocks on exchange rates," Working Paper Series, Macroeconomic Issues 92-32, Federal Reserve Bank of Chicago.
  10. Rogers, John H., 1999. "Monetary shocks and real exchange rates," Journal of International Economics, Elsevier, vol. 49(2), pages 269-288, December.
  11. Reuven Glick & Kenneth Rogoff, 1992. "Global versus country-specific productivity shocks and the current account," Working Papers in Applied Economic Theory 92-06, Federal Reserve Bank of San Francisco.
  12. Jomana Amara & David Papell, 2006. "Testing for Purchasing Power Parity using stationary covariates," Applied Financial Economics, Taylor & Francis Journals, vol. 16(1-2), pages 29-39.
  13. repec:cup:etheor:v:11:y:1995:i:5:p:1148-71 is not listed on IDEAS
  14. Alan M. Taylor, 2000. "Potential Pitfalls for the Purchasing-Power-Parity Puzzle? Sampling and Specification Biases in Mean-Reversion Tests of the Law of One Price," NBER Working Papers 7577, National Bureau of Economic Research, Inc.
  15. Graham Elliott & Michael Jansson & Elena Pesavento, 2005. "Optimal Power for Testing Potential Cointegrating Vectors With Known Parameters for Nonstationarity," Journal of Business & Economic Statistics, American Statistical Association, vol. 23, pages 34-48, January.
  16. Abuaf, Niso & Jorion, Philippe, 1990. " Purchasing Power Parity in the Long Run," Journal of Finance, American Finance Association, vol. 45(1), pages 157-74, March.
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  18. Matthew Higgins & Egon Zakrajsek, 1999. "Purchasing power parity: three stakes through the heart of the unit root null," Staff Reports 80, Federal Reserve Bank of New York.
  19. Yin-Wong Cheung & Kon S. Lai, 1999. "On Cross-Country Differences in the Persistence of Real Exchange Rates," CESifo Working Paper Series 218, CESifo Group Munich.
  20. Ng, S. & Perron, P., 1994. "Unit Root Tests ARMA Models with Data Dependent Methods for the Selection of the Truncation Lag," Cahiers de recherche 9423, Universite de Montreal, Departement de sciences economiques.
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  22. Serena Ng & Pierre Perron, 1997. "Lag Length Selection and the Construction of Unit Root Tests with Good Size and Power," Boston College Working Papers in Economics 369, Boston College Department of Economics, revised 01 Sep 2000.
  23. Beaudry, Paul & Devereux, Michael B., 1995. "Money and the real exchange rate with sticky prices and increasing returns," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 43(1), pages 55-101, December.
  24. Lothian, James R., 1997. "Multi-country evidence on the behavior of purchasing power parity under the current float," Journal of International Money and Finance, Elsevier, vol. 16(1), pages 19-35, February.
  25. Maurice Obstfeld., 1993. "Model Trending Real Exchange Rates," Center for International and Development Economics Research (CIDER) Working Papers C93-011, University of California at Berkeley.
  26. Elliott, Graham & Rothenberg, Thomas J & Stock, James H, 1996. "Efficient Tests for an Autoregressive Unit Root," Econometrica, Econometric Society, vol. 64(4), pages 813-36, July.
  27. Engel, Charles & Hendrickson, Michael K. & Rogers, John H., 1997. "Intranational, Intracontinental, and Intraplanetary PPP," Journal of the Japanese and International Economies, Elsevier, vol. 11(4), pages 480-501, December.
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