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An Unbiased Appraisal of Purchasing Power Parity

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  • C. John McDermott
  • Paul Cashin

Abstract

Univariate studies of the hypothesis of unit roots in real exchange rates have yielded consensus point estimates of the half-life of deviations from purchasing power parity of between three to five years. However, least squares-based estimates of half-lives are biased downward. Accordingly, we follow Andrews (1993) and use median-unbiased estimators of the half-life of deviations from parity as a preferred measure of the persistence of real exchange rate shocks. We study this issue using real effective exchange rate (REER) data for 22 industrial countries in the post-Bretton Woods period. Three methods of bias correction are implemented, which yield cross-country averages of half-lives of deviations from parity ranging between 4 to 15 years, with the REER of several countries displaying permanent deviations from parity.

Suggested Citation

  • C. John McDermott & Paul Cashin, 2001. "An Unbiased Appraisal of Purchasing Power Parity," IMF Working Papers 01/196, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:01/196
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    Cited by:

    1. Shiu-Sheng Chen & Charles Engel, 2005. "Does 'Aggregation Bias' Explain The Ppp Puzzle?," Pacific Economic Review, Wiley Blackwell, vol. 10(1), pages 49-72, February.
    2. Qian Chen & David E. Giles, 2007. "A Saddlepoint Approximation to the Distribution of the Half-Life Estimator in an Autoregressive Model: New Insights Into the PPP Puzzle," Econometrics Working Papers 0703, Department of Economics, University of Victoria.
    3. Levent, Korap, 2007. "Modeling purchasing power parity using co-integration: evidence from Turkey," MPRA Paper 19584, University Library of Munich, Germany.
    4. Cuestas, Juan Carlos & Regis, Paulo José, 2013. "Purchasing power parity in OECD countries: Nonlinear unit root tests revisited," Economic Modelling, Elsevier, vol. 32(C), pages 343-346.
    5. Fullerton Jr., Thomas M. & Fierro, Karen P. & Villalobos, Emmanuel, 2009. "Cross-border restaurant price and exchange rate interactions," The North American Journal of Economics and Finance, Elsevier, vol. 20(3), pages 281-288, December.
    6. Alberola, Enrique & Lopez, Humberto & Serven, Luis, 2004. "Tango with the Gringo: the hard peg and real misalignment in Argentina," Policy Research Working Paper Series 3322, The World Bank.
    7. Fallahi, Firouz & Karimi, Mohammad & Voia, Marcel-Cristian, 2016. "Persistence in world energy consumption: Evidence from subsampling confidence intervals," Energy Economics, Elsevier, vol. 57(C), pages 175-183.
    8. repec:eee:eneeco:v:63:y:2017:i:c:p:272-287 is not listed on IDEAS
    9. Irfan Civcir, 2003. "Before the Fall, Was the Turkish Lira Overvalued?," Eastern European Economics, Taylor & Francis Journals, vol. 41(2), pages 69-99, March.
    10. repec:eee:eneeco:v:65:y:2017:i:c:p:228-239 is not listed on IDEAS
    11. Jean Imbs & Haroon Mumtaz & Morten O. Ravn & Hélène Rey, 2005. "PPP Strikes Back: Aggregation And the Real Exchange Rate," The Quarterly Journal of Economics, Oxford University Press, vol. 120(1), pages 1-43.
    12. Paul Cashin & C. John McDermott, 2006. "Parity Reversion in Real Exchange Rates: Fast, Slow, or Not at All?," IMF Staff Papers, Palgrave Macmillan, vol. 53(1), pages 1-5.
    13. Aviral Tiwari & Muhammad Shahbaz, 2014. "Revisiting Purchasing Power Parity for India using threshold cointegration and nonlinear unit root test," Economic Change and Restructuring, Springer, vol. 47(2), pages 117-133, May.
    14. Joseph Kargbo, 2006. "Purchasing Power Parity and real exchange rate behaviour in Africa," Applied Financial Economics, Taylor & Francis Journals, vol. 16(1-2), pages 169-183.
    15. Blanco-Gonzalez, Lorenzo & Fullerton, Thomas Jr., 2006. "Borderplex menu evidence for the law of one price," Economics Letters, Elsevier, vol. 90(1), pages 28-33, January.
    16. Levent, Korap, 2007. "Analyzing CBRT's FOREX interventions using EGARCH (2001-2006)," MPRA Paper 20634, University Library of Munich, Germany.
    17. Joseph Kargbo, 2011. "Capital flows, real exchange rate misalignment and PPP tests in emerging market countries," Applied Economics, Taylor & Francis Journals, vol. 43(15), pages 1883-1897.
    18. Levent, Korap, 2007. "Information content of exchange rate volatility: Turkish experience," MPRA Paper 19598, University Library of Munich, Germany.
    19. Susan Thorp, 2004. "That Courage is not inconsistent with Caution: Foreign Currency Hedging for Superannuation Funds," Econometric Society 2004 Australasian Meetings 148, Econometric Society.
    20. Emilio Pineda & Paul Cashin & Yan M Sun, 2009. "Assessing Exchange Rate Competitiveness in the Eastern Caribbean Currency Union," IMF Working Papers 09/78, International Monetary Fund.
    21. Blanco-Gonzalez, Lorenzo & Fullerton, Thomas M., Jr., 2008. "La Ley del Precio Unitario en la Zona Metropolitana Fronteriza
      [The Law of One Price in the Borderplex]
      ," MPRA Paper 14687, University Library of Munich, Germany.

    More about this item

    Keywords

    Foreign exchange; Purchasing power parity; Median-unbiased estimation; shock persistence; exchange rate; exchange rates; confidence intervals; confidence interval; real exchange rates;

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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