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On PPP, Unit Roots and Panels

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  • Wagner, Martin

    (Department of Economics and Finance, Institute for Advanced Studies, Vienna, Austria)

Abstract

This paper re-assesses the panel (unit root test) evidence for PPP on four monthly data sets. We discuss and illustrate that commonly-used first generation panel unit root tests are inappropriate for PPP analysis since they are constructed for cross-sectionally uncorrelated panels. Given that real exchange rate panel data sets are – almost by construction – highly cross-sectionally correlated, so called second generation panel unit root methods that allow for and model cross-sectional dependence should be applied. Using inappropriate first generation tests, quite strong evidence for PPP is found. However, this evidence vanishes entirely when resorting to an appropriate method (e.g. the one developed in Bai and Ng, 2004a) for nonstationary cross-sectionally correlated panels. We strongly believe that our findings are relevant beyond the data sets investigated here for illustration.

Suggested Citation

  • Wagner, Martin, 2005. "On PPP, Unit Roots and Panels," Economics Series 176, Institute for Advanced Studies.
    • Handle: RePEc:ihs:ihsesp:176
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    2. Månsson, Kristofer & Sjölander, Pär, 2014. "Testing for nonlinear panel unit roots under cross-sectional dependency — With an application to the PPP hypothesis," Economic Modelling, Elsevier, vol. 38(C), pages 121-132.
    3. Syed, Munawar-Shah & Mariani, Abdul-Majid & Syed, Hussain-Shah, 2014. "Assessing Fiscal Sustainability for SAARC and IMT-GT Countries," MPRA Paper 62815, University Library of Munich, Germany, revised 2014.
    4. Miguel Carvalho & Paulo Júlio, 2012. "Digging out the PPP hypothesis: an integrated empirical coverage," Empirical Economics, Springer, vol. 42(3), pages 713-744, June.
    5. Helmut Herwartz & Florian Siedenburg, 2010. "A New Approach to Unit Root Testing," Computational Economics, Springer;Society for Computational Economics, vol. 36(4), pages 365-384, December.
    6. Smeekes Stephan, 2011. "Bootstrap Sequential Tests to Determine the Stationary Units in a Panel," Research Memorandum 003, Maastricht University, Maastricht Research School of Economics of Technology and Organization (METEOR).
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    8. Raihan, Selim & Abdullah, S M & Barkat, Aroni & Siddiqua, Salina, 2017. "Mean Reversion of the Real Exchange Rate and the validity of PPP Hypothesis in the context of Bangladesh: A Holistic Approach," MPRA Paper 77172, University Library of Munich, Germany.
    9. García Solanes, José & Torrejón-Flores, Fernando, 2009. "The Balassa-Samuelson Hypothesis in Developed Countries and Emerging Market Economies: Different Outcomes Explained," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy (IfW), vol. 3, pages 1-24.
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    11. Syed A. Basher & Josep Lluis Carrión-i-Silvestre, 2008. "Deconstructing Shocks and Persistence in OECD Real Exchange Rates," Working Papers XREAP2008-06, Xarxa de Referència en Economia Aplicada (XREAP), revised Jun 2008.
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    13. Wagner, Martin, 2005. "The Balassa-Samuelson Effect in 'East & West'. Differences and Similarities," Economics Series 180, Institute for Advanced Studies.
    14. Jorg Breitung & Gianluca Cubadda, 2009. "Testing for cointegration in high-dimensional systems," CEIS Research Paper 148, Tor Vergata University, CEIS, revised 30 Sep 2009.
    15. Paolo Agnolucci & Andrew Venn, 2011. "Industrial energy intensities in the UK: is there a deterministic or stochastic difference among sectors?," Applied Economics, Taylor & Francis Journals, vol. 43(12), pages 1447-1462.
    16. Herwartz, Helmut & Siedenburg, Florian, 2009. "A new approach to unit root testing," Economics Working Papers 2009-06, Christian-Albrechts-University of Kiel, Department of Economics.

    More about this item

    Keywords

    PPP; Real exchange rate index; Unit root; Panel; Cross-sectional dependence; Factor model;

    JEL classification:

    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • F30 - International Economics - - International Finance - - - General
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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