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Non-linear adjustment in law of one price deviations and physical characteristics of goods

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  • Berka, Martin

Abstract

At a level of individual goods, heterogeneity of marginal transaction costs, proxied by price-to-weight ratios and stowage factors, explains a large part of the variation in thresholds of no-adjustment and conditional half-lives of law of one price deviations. Prices of heavier more voluminous) goods deviate further before becoming mean-reverting. Moreover, after becoming mean-reverting, prices of heavier goods converge more slowly. Together with measures of pricing power, market size, distance and exchange rate volatility, these factors explain up to 43% of variation in no-adjustment threshold estimates across 52 goods in US-Canada post Bretton Woods monthly CPI data and are robust in a broader 5-country dataset. They open two avenues for the importance of marginal transaction costs in accounting for real exchange rate persistence: through (a) generating persistence in individual real exchange rate components, and (b) accentuating it by the process of aggregation of heterogeneous components (”aggregation bias” of Imbs, et al. 2005).

Suggested Citation

  • Berka, Martin, 2006. "Non-linear adjustment in law of one price deviations and physical characteristics of goods," MPRA Paper 8606, University Library of Munich, Germany, revised Dec 2007.
  • Handle: RePEc:pra:mprapa:8606
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    References listed on IDEAS

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    Cited by:

    1. Berka, Martin, 2005. "General Equilibrium Model of Arbitrage Trade and Real Exchange Rate Persistence," MPRA Paper 234, University Library of Munich, Germany.
    2. Pavlidis, Efthymios G. & Paya, Ivan & Peel, David A., 2011. "Real exchange rates and time-varying trade costs," Journal of International Money and Finance, Elsevier, vol. 30(6), pages 1157-1179, October.
    3. Frank Mueller‐Langer, 2012. "Parallel Trade and its Ambiguous Effects on Global Welfare," Review of International Economics, Wiley Blackwell, vol. 20(1), pages 177-185, February.
    4. Ozlem Inanc & Marios Zachariadis, 2006. "International Price Dispersion and the Direction of Trade," University of Cyprus Working Papers in Economics 2-2006, University of Cyprus Department of Economics.
    5. Gawon Yoon, 2010. "Nonlinearity in real exchange rates: an approach with disaggregated data and a new linearity test," Applied Economics Letters, Taylor & Francis Journals, vol. 17(11), pages 1125-1132.
    6. James MacGee & Chris Hajzler, 2012. "Retail Price Differences across U.S. and Canadian Cities during the Interwar Period," 2012 Meeting Papers 1126, Society for Economic Dynamics.
    7. Liontakis, Angelos E. & Papadas, Christos T., 2009. "Distribution Dynamics of Food Price Inflation Rates in EU: An Alternative Conditional Density Estimator Approach," 113th Seminar, September 3-6, 2009, Chania, Crete, Greece 58084, European Association of Agricultural Economists.

    More about this item

    Keywords

    Law of One Price Deviations; Real Exchange Rate Persistence; Non-Linearities; transaction costs; Physical Weight; Physical Volume; Threshold Autregres-sive Models;

    JEL classification:

    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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