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A Reappraisal of the Border Effect on Relative Price Volatility

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  • Yin-wong Cheung

    (University of California, Santa Cruz)

  • Kon S. Lai

    (California State University, Los Angeles)

Abstract

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 reevaluating 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 proportion of the border effect.

Suggested Citation

  • Yin-wong Cheung & Kon S. Lai, 2006. "A Reappraisal of the Border Effect on Relative Price Volatility," Working Papers 042006, Hong Kong Institute for Monetary Research.
    • Handle: RePEc:hkm:wpaper:042006
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    References listed on IDEAS

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    1. Engel, Charles, 1993. "Real exchange rates and relative prices : An empirical investigation," Journal of Monetary Economics, Elsevier, vol. 32(1), pages 35-50, August.
    2. Engel, Charles & Rogers, John H, 1996. "How Wide Is the Border?," American Economic Review, American Economic Association, vol. 86(5), pages 1112-1125, December.
    3. Charles Engel & John H. Rogers, 1998. "Relative price volatility: what role does the border play?," International Finance Discussion Papers 623, Board of Governors of the Federal Reserve System (U.S.).
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    5. 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.
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    8. Engel, Charles & Rogers, John H, 2001. "Violating the Law of One Price: Should We Make a Federal Case Out of It?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(1), pages 1-15, February.
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    14. Parsley, David C. & Wei, Shang-Jin, 2001. "Explaining the border effect: the role of exchange rate variability, shipping costs, and geography," Journal of International Economics, Elsevier, vol. 55(1), pages 87-105, October.
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    Cited by:

    1. Pippenger, John, 2022. "The Law Of One Price, Borders And Purchasing Power Parity," University of California at Santa Barbara, Economics Working Paper Series qt5b17d1dr, Department of Economics, UC Santa Barbara.
    2. Heijdra, Ben J. & Ligthart, Jenny E., 2010. "The Transitional Dynamics Of Fiscal Policy In Small Open Economies," Macroeconomic Dynamics, Cambridge University Press, vol. 14(1), pages 1-28, February.
    3. repec:dau:papers:123456789/179 is not listed on IDEAS
    4. Dmitry Kulikov, 2015. "Law of One Price in the euro area: an empirical investigation using Nielsen disaggregated price data," Bank of Estonia Working Papers wp2014-10, Bank of Estonia, revised 20 Jan 2015.
    5. Pippenger, John, 2015. "Arbitrage and the Law of One Price: Setting the Record Straight," University of California at Santa Barbara, Economics Working Paper Series qt27t4q265, Department of Economics, UC Santa Barbara.

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    More about this item

    Keywords

    Price volatility; exchange rate volatility; national border; distance; dissimilar shocks;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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