IDEAS home Printed from https://ideas.repec.org/p/pra/mprapa/100764.html

Does the purchasing power parity theory still hold ? The UK as the case study

Author

Listed:
  • Ashraf, Kamran
  • Masih, Mansur

Abstract

The purchasing power parity (PPP) theory is an integral part of international finance. The PPP examines the relationship between the inflation rate differential between two countries and their exchange rate movements. The purpose of this study is to investigate whether the PPP still holds or not. The UK is taken as a case study. The standard time series techniques are employed to address the issue. Our findings tend to indicate that the PPP theory does hold in the long run as evidenced in the cointegration (or comovement) of the exchange rate and price ratio variable. Furthermore, the Granger-causality analysis unveils that an exogenous shock to the US-UK exchange rate disturbs the long run equilibrium and the domestic-foreign price ratio variable bears the brunt of short-run adjustment to bring about the long run PPP equilibrium. The exchange rate is found to be the exogenous leading variable and the price ratio variable is found to play the role of a follower in terms of endogenous adjustment. The findings have strong policy implications for international trade and investment.

Suggested Citation

  • Ashraf, Kamran & Masih, Mansur, 2017. "Does the purchasing power parity theory still hold ? The UK as the case study," MPRA Paper 100764, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:100764
    as

    Download full text from publisher

    File URL: https://mpra.ub.uni-muenchen.de/100764/1/MPRA_paper_100764.pdf
    File Function: original version
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Frenkel, Jacob A., 1981. "The collapse of purchasing power parities during the 1970's," European Economic Review, Elsevier, vol. 16(1), pages 145-165.
    2. Apostolos Serletis, 1994. "Maximum likelihood cointegration tests of purchasing power parity: Evidence from seventeen OECD countries," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 130(3), pages 476-493, September.
    3. Layton, Allan P. & Stark, Jonathan P., 1990. "Co-integration as an empirical test of purchasing power parity," Journal of Macroeconomics, Elsevier, vol. 12(1), pages 125-136.
    4. Abuaf, Niso & Jorion, Philippe, 1990. "Purchasing Power Parity in the Long Run," Journal of Finance, American Finance Association, vol. 45(1), pages 157-174, March.
    5. Corbae, Dean & Ouliaris, Sam, 1988. "Cointegration and Tests of Purchasing Power Parity," The Review of Economics and Statistics, MIT Press, vol. 70(3), pages 508-511, August.
    6. Robert Engle & Clive Granger, 2015. "Co-integration and error correction: Representation, estimation, and testing," Applied Econometrics, Russian Presidential Academy of National Economy and Public Administration (RANEPA), vol. 39(3), pages 106-135.
    7. Johansen, Søren & Juselius, Katarina, 1992. "Testing structural hypotheses in a multivariate cointegration analysis of the PPP and the UIP for UK," Journal of Econometrics, Elsevier, vol. 53(1-3), pages 211-244.
    8. Alston Flynn, N. & Boucher, Janice L., 1993. "Tests of long-run Purchasing Power Parity using alternative methodologies," Journal of Macroeconomics, Elsevier, vol. 15(1), pages 109-122.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Joseph M. Kargbo, 2004. "Purchasing Power Parity And Exchange Rate Policy Reforms In Africa," South African Journal of Economics, Economic Society of South Africa, vol. 72(2), pages 258-281, June.
    2. Goh, Soo Khoon & Mithani, Dawood, 2000. "Deviation from Purchasing Power Parity: Evidence from Malaysia, 1973–1997," MPRA Paper 51922, University Library of Munich, Germany.
    3. Froot, Kenneth A. & Rogoff, Kenneth, 1995. "Perspectives on PPP and long-run real exchange rates," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 32, pages 1647-1688, Elsevier.
    4. Cheng, Benjamin S., 1999. "Beyond the purchasing power parity: testing for cointegration and causality between exchange rates, prices, and interest rates," Journal of International Money and Finance, Elsevier, vol. 18(6), pages 911-924, December.
    5. Kawai, Masahiro & Ohara, Hidetaka, 1997. "Nonstationarity of Real Exchange Rates in the G7 Countries: Are They Cointegrated with Real Variables?," Journal of the Japanese and International Economies, Elsevier, vol. 11(4), pages 523-547, December.
    6. Thomas L Bradley & Paul B Eberle, 2023. "Purchasing Power Parity In Russia And The Transitioning Economy 1990-1995," Review of Economic and Business Studies, Alexandru Ioan Cuza University, Faculty of Economics and Business Administration, issue 31, pages 85-111, June.
    7. Jean-Francois Villeneuve & Jagdish Handa, 2006. "Purchasing Power Parity as a long-term memory process: evidence from Canada," Applied Financial Economics, Taylor & Francis Journals, vol. 16(1-2), pages 109-117.
    8. Razzaque H. Bhatti, 1996. "A Correct Test of Purchasing Power Parity: The Case of Pak-Rupee Exchange Rates," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 35(4), pages 671-682.
    9. A. Mansur & M. Masih & Rumi Masih, 2004. "Fractional cointegration, low frequency dynamics and long-run purchasing power parity: an analysis of the Australian dollar over its recent float," Applied Economics, Taylor & Francis Journals, vol. 36(6), pages 593-605.
    10. Cushman, David O. & Sang Sub Lee & Thorgeirsson, Thorsteinn, 1996. "Maximum likelihood estimation of cointegration in exchange rate models for seven inflationary OECD countries," Journal of International Money and Finance, Elsevier, vol. 15(3), pages 337-368, June.
    11. Abdol Soofi, 1998. "A fractional cointegration test of purchasing power parity: the case of selected members of OPEC," Applied Financial Economics, Taylor & Francis Journals, vol. 8(6), pages 559-566.
    12. repec:isu:genstf:1998010108000013534 is not listed on IDEAS
    13. Song, Chi-Young, 1997. "The Real Exchange Rate and the Current Account Balance in Japan," Journal of the Japanese and International Economies, Elsevier, vol. 11(2), pages 143-184, June.
    14. Jerry Coakley & Stuart Snaith, 2006. "Testing for symmetry and proportionality in a European panel," Applied Financial Economics, Taylor & Francis Journals, vol. 16(1-2), pages 63-71.
    15. Kargbo, Joseph M., 2003. "Cointegration Tests of Purchasing Power Parity in Africa," World Development, Elsevier, vol. 31(10), pages 1673-1685, October.
    16. Ritesh Kumar Mishra & Sanjay Sehgal, 2011. "Exchange rates and prices in purchasing power parity framework: Are bilateral real exchange rates stationary?," International Journal of Economic Policy in Emerging Economies, Inderscience Enterprises Ltd, vol. 4(3), pages 274-286.
    17. Sarno, Lucio & Valente, Giorgio, 2006. "Deviations from purchasing power parity under different exchange rate regimes: Do they revert and, if so, how?," Journal of Banking & Finance, Elsevier, vol. 30(11), pages 3147-3169, November.
    18. Giorgio Canarella & Stephen M. Miller & Stephen K. Pollard, 2012. "Purchasing Power Parity between the UK and the Euro Area," Working Papers 1208, University of Nevada, Las Vegas , Department of Economics.
    19. Edison, Hali J. & Gagnon, Joseph E. & Melick, William R., 1997. "Understanding the empirical literature on purchasing power parity: the post-Bretton Woods era," Journal of International Money and Finance, Elsevier, vol. 16(1), pages 1-17, February.
    20. Lucio Sarno & Mark P. Taylor, 2002. "Purchasing Power Parity and the Real Exchange Rate," IMF Staff Papers, Palgrave Macmillan, vol. 49(1), pages 1-5.
    21. Denisard Alves & Regina Celia Cati & Vera Lucia Fava, 2001. "Purchasing power parity in Brazil: a test for fractional cointegration," Applied Economics, Taylor & Francis Journals, vol. 33(9), pages 1175-1185.

    More about this item

    Keywords

    ;
    ;
    ;
    ;
    ;
    ;

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:pra:mprapa:100764. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Joachim Winter (email available below). General contact details of provider: https://edirc.repec.org/data/vfmunde.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.