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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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  2. 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.
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  8. 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.
  9. 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.
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  19. 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.
  20. Serena Ng & Pierre Perron, 2001. "LAG Length Selection and the Construction of Unit Root Tests with Good Size and Power," Econometrica, Econometric Society, vol. 69(6), pages 1519-1554, November.
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  25. 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.
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  27. 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.
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