IDEAS home Printed from
   My bibliography  Save this paper

Re-examining the Purchasing Power Parity Hypothesis Over Two centuries


  • John T. Cuddington

    (Georgetown University)

  • Hong Liang

    (Georgetown University)


This paper reexamines the stationarity of the dollar-sterling real exchange rate using the two centuries of data analyzed in Lothian and Taylor (LT) (1996). We fit univariate time series models for the real exchange rate that dominate the stationary AR(1) specification chosen by LT and the random walk alternative they consider. The differences in our conlusions arise from two primary sources: (1) choice of lag length in the augmented Dickey-Fuller regressions on which the unit root tests are based, and/or (2) realization that the absence of a unit root is necessary but not sufficient for stationarity. Deterministic time trends (and structural breaks) can also give rise to nonstationary RER series. LT (1996) also compare the out-of-sample forecasting results of their stationary AR(1) model with the random work model over the 1973-90 period. They find that the AR(1) forecasts outperform the random walk model. Moreover, the relative superiority of the AR(1) model increases monotonically as the forecast horizon extends from one year to five years. We find that the dollar-sterling real exchange rate is better modeled as either trend stationary process or as a difference stationary process with an MA(5) error. Compared with these two non-stationary specifications, the AR(1) model no longer dominates in out-of-sample forecasts at all time horizons. When the out-of-sample forecasting exercise extends from 1946 onward, our non-stationary models strictly dominate the stationary AR(1) specification. Moreover, the latter forecast exercise indicates the stability of the non-stationary specifications over the pre-float and recent floating rate period. Our results suggest, contrary to LT, that long-run PPP does not hold for the dollar-sterling exchange rate.

Suggested Citation

  • John T. Cuddington & Hong Liang, 1998. "Re-examining the Purchasing Power Parity Hypothesis Over Two centuries," International Trade 9802004, EconWPA.
  • Handle: RePEc:wpa:wuwpit:9802004
    Note: Type of Document - Microsoft Word 97; prepared on IBM PC; to print on HP; pages: 14 ; figures: included. The authors thank Jim Lothian for providing the data set used in this study.

    Download full text from publisher

    File URL:
    Download Restriction: no

    File URL:
    Download Restriction: no

    File URL:
    Download Restriction: no

    File URL:
    Download Restriction: no


    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.

    Cited by:

    1. Cuddington, John T. & Liang, Hong, 2000. "Purchasing power parity over two centuries?," Journal of International Money and Finance, Elsevier, vol. 19(5), pages 753-757, October.

    More about this item

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F40 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - General

    NEP fields

    This paper has been announced in the following NEP Reports:


    Access and download statistics


    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:wpa:wuwpit:9802004. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (EconWPA). General contact details of provider: .

    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.

    We have no references for this item. You can help adding them by using 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.

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

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.