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Testing Long-Run Purchasing Power Parity with a Bayesian Unit Root Approach: The Experience of Canada in the 1950s.
Applied Economics
Abstract
A test is made for long-run purchasing power parity with Canadian monthly and quarterly data from the 1950s using a Bayesian unit-root test discussed by Koop, but first suggested by Zellner and Siow. Results show that the hypothesis that the real exchange rate is a stationary process receives relatively low posterior probability. Put differently, the probability is low that the nominal exchange rate and the national price levels have a stable long-run relationship. Furthermore, it is also found that there are structural differences between the sample period from October 1950 to May 1962 and the sample period from January 1952 to November 1960.
... However, all study focus on validity of PPP on the long-run has produced mixed results (Anoruo et al., 2005). For example (Jayaraman & Choong, 2014;Paul & Motlaleng, 2008, 2006Abuaf & Jorion, 1990; Meese & Rogoff, 1988) have evidence to support the PPP in a long-run, while (Cooper, 1994;Ahking, 1997) obtained evidence against it. Paul and Motlaleng (2006) in their literature note the validity of the long-run PPP theory using annual data of sixteen African countries from period covering 1981 to 1994. ...
... However, all study focus on validity of PPP on the long-run has produced mixed results (Anoruo et al., 2005). For example (Jayaraman & Choong, 2014;Paul & Motlaleng, 2008, 2006Abuaf & Jorion, 1990; Meese & Rogoff, 1988) have evidence to support the PPP in a long-run, while (Cooper, 1994;Ahking, 1997) obtained evidence against it. Paul and Motlaleng (2006) in their literature note the validity of the long-run PPP theory using annual data of sixteen African countries from period covering 1981 to 1994. ...
... On the contrary (Cooper, 1994) investigated the validity of PPP by testing unit root and cointegration for Australian, New Zealand and Singaporean currencies from 1973-1992 and found that both tests fail to satisfy long-run PPP. Later (Ahking, 1997) employ a more advanced Bayesian unit root approach and found that there is little probability that exchange rate and price level have a steady relationship in a longrun. ...
We have tested the purchase power parity hypothesis using the consumer price index of USA and UK against Solomon Islands for the sample monthly period from January 1993 to December 2013. This paper uses cointegration and the error correction as methodologies as the data are found to be non-stationary. The result shows that the changes in Solomon Dollars (SBD) per USD are influenced by the long term trends in the price differential of Solomon Islands and the USA. We further investigate the changes in the price differential between Solomon Islands and the UK and establish that they both have a similar trend. The paper asserts that the inflation differential is in the direction of the appreciation of the SBD/USD and SBD/UK pound which supports the PPP theory in the long run. The symmetry and proportionality of the strong version of PPP were found to be very significant for Solomon Islands against UK pound sterling only and not against USA Dollars.
... However, similar conclusions are not established in every case of finding the rationality of PPP theory in the long run. While for example, Meese and Rogoff (1988), Kim (1990), Abuaf and Jorian (1990), Becketti, Hakkio, and Joines (1995), Glen (1992), and Pippenger (1993) find confirmation of the theory in the long run, whereas Ahking (1997) and Cooper (1994) find the opposite result. However, the studies by Baillie and Patrick (1989), Chowdhury and Sdogati (1993), Corbae and Ouliaris (1988), Flynn and Boucher (1993), and Beng (1991) find proof in support of rejecting the hypothesis. ...
... Different researchers use diverse approaches for obtaining desired results. For example, Whitt (1992); Manzur and Ariff (1995) have used Sim tests; Johansen (1988) has employed the maximum likelihood procedure and Monte-Carlo simulations; Ahking (1997) has used the Bayesian unit root approach; Engle and Granger (1987) two-step approach has been used by Huang and Yang (1996) and generalized error correction model has been tested by Lee (1999) using the data of 13 Asian countries. Several studies also test the stationarity of real exchange rates based on the post-Bretton-Woods period information. ...
Purpose: This study aims to empirically assess the rationality of Purchasing Power Parity (PPP) theory in Developing-8 (D-8) countries. For this purpose, the data of PPP, Consumer Price Index (CPI), and Wholesale Price Index (WPI) were used from 1990 to 2015, with annual frequency. Methodology: This paper attempted to set up the long-run association between the nominal exchange rate and relative prices as opposed to old investigations. This study applies the ADF, PP, and the recently developed KPSS test to test data stationarity, followed by a cointegration test, granger casualty test, and vector error correction model. Findings: Time-series properties of this study specify that the real exchange rates are stationary for sample countries, indicating PPP holds in these countries, whereas Cointegration results demonstrate that a strong cointegrating relationship exists among the variables of Bangladesh and Turkey only. Practical Implications: The findings of the study have some policy implications, which suggest some recommendations for bilateral trade among these countries. Originality: Findings of the paper suggest that the structure of these developing eight (D-8) countries tends to be less diverse, and fewer economic changes occur than in developed countries. Limitations: Findings of this paper can vary on a different set of databases depending on the changing pattern of CPI and WPI.
... For instance, Abuaf and Jorian [1990], Darby [1983], Baillie and Selover [1987], Meese and Rogoff [1988], Mark [1990] and Hakkio [1984] found evidence of PPP in the long-run. In contrast, Cooper [1994], Messe and Singleton [1982], and Ahking [1997] found evidence against PPP in the long-run. Meese and Singleton [1982] marked the turning point in the investigation of PPP. ...
... Besides, the significance and signs of the coefficients are not robust to changes in the lag selection procedures for most of the groups, which also demonstrate a very insubstantial support for the PPP with either black market or official data. Similar results have been found by Adler and Lehmann (1983), Manzur (1990), Huang and Yang (1996), Ahking (1997), and Bahmani-Oskooee and Goswami (2005). They all have failed to detect the long run stationarity of PPP using different types of tests. ...
Testing purchasing power parity (PPP) using black market exchange rate data has gained popularity in recent times. It is claimed that black market exchange rate data more often support the PPP than the official exchange rate data. In this study, to assess both the long run stability of exchange rate and the short run dynamics, we employ Pooled Mean Group (PMG) Estimation developed by Pesaran et al. (1999) on eight groups of countries based on different criteria. Using the famous Reinhart and Rogoff (2002) dataset on black market exchange rate in the framework of BahmaniOskooee and Goswami (2005), the results are in sharp contrast with the most recent studies. We find very weak and insufficient support for the PPP using both the black market and the official exchange rate data. The assumption of long run homogeneity is also invalidated for some groups. Therefore, the results of PPP testing are not conclusive even though we switch from the official rate to the black market rate for a global data set. The finding holds even though we swap static panel for dynamic heterogeneous panel in the light of PMG estimation.
... The evidence from the unit root literature for the PPP hypothesis is inconclusive (Sarno and Taylor, 2002). Studies which have found evidence of PPP include Abuaf and Jorian (1990), Meese and Rogoff (1988) and Taylor, (2002), while studies such as Ahking (1997), Cooper (1994 and Meese and Singleton (1982) have found evidence against PPP. Among studies of PPP in Asian countries the evidence from univariate unit root tests is also mixed. ...
In this article we apply univariate and panel Lagrange Multiplier (LM) unit root tests with one and twostructural breaks proposed by Lee and Strazicich (2003, 2004) and Im et al. (2005) to examine housing prices for five different housing price indices (all housing, detached housing, semi-detached housing, terrace housing and high-rise housing) in 14 states of Malaysia to test whether housing prices exhibit a random walk. Our main finding from the univariate LM unit root tests is that for the vast majority of states housing prices follow a stationary process about a segmented trend. The results of the panel LM unit root tests provide overwhelming evidence that house prices are segmented trend reverting.
... The evidence from the unit root literature for the PPP hypothesis is inconclusive (Sarno and Taylor, 2002). Studies which have found evidence of PPP include Abuaf and Jorian (1990), Meese and Rogoff (1988) and Taylor, (2002), while studies such as Ahking (1997), Cooper (1994 and Meese and Singleton (1982) have found evidence against PPP. Among studies of PPP in Asian countries the evidence from univariate unit root tests is also mixed. ...
There are a number of studies that examine the purchasing power parity (PPP) hypothesis. The empirical findings from the extant literature for the PPP hypothesis are mixed. This paper applies univariate and panel LM unit root tests with one and two structural breaks to real exchange rates for 15 Asian countries. The univariate LM unit root tests find evidence of PPP for two-thirds of the sample. The results from the panel LM unit root test support long-run PPP for the Asian countries in the sample. The results from the LM panel unit root tests differ from those of existing panel unit root tests of PPP for Asian countries that have not allowed for the existence of structural breaks.
... Bayesian approach [Schotman and van Dijk (1991), Whitt (1992), and Ahking (1997)]. Long-run PPP requires that the real exchange rate is a stationary time series. ...
Some researchers, for example, Koop (1992), and Sims (1988), advocated for Bayesian alternatives to unit-root testing over the classical approach using the augmented Dickey-Fuller test (ADF). This paper studies the power of what Koop (1992) has called the "Objective" Bayesian approach to unit-root testing. Koop's "objective" Bayesian test is interesting in light of the call by Phillips (1991a, 1991b) for more objective Bayesian analysis of time series. We apply the "objective" Bayesian unit-root test to a study of long-run purchasing power parity (PPP) in the post-Bretton Woods era and also Monte Carlo simulations. Overall, our results suggest that the "objective" Bayesian test is biased in favor of trend-stationarity. We conclude that, at least for the "objective" Bayesian test, it is not better than the classical ADF approach in unit-root tests, and because of its bias, the "objective" priors suggested by Koop is not appropriate.
... The evidence for the PPP hypothesis is inconclusive (Sarno and Taylor, 2002;Taylor, 2006). Studies which have found evidence of PPP include Abuaf and Jorian (1990), Meese and Rogoff (1988) and Taylor, (2002), while studies such as Ahking (1997), Cooper (1994), Lopez et al. (2005) and Meese and Singleton (1982) have found evidence against PPP. Among studies of PPP in Asian countries the evidence from univariate unit root tests is also mixed. ...
There are a number of studies that examine the purchasing power parity (PPP) hypothesis. The empirical findings from the extant literature for the PPP hypothesis are mixed. This article applies univariate and panel Lagrange Multiplier (LM) unit root tests with one and two structural breaks to real exchange rates for 15 Asian countries. The univariate LM unit root tests find evidence of PPP for two-thirds of the sample. The results from the panel LM unit root test support long-run PPP for the Asian countries in the sample. The results from the LM panel unit root tests differ from those of existing panel unit root tests of PPP for Asian countries that have not allowed for the existence of structural breaks.
This study revisits purchasing power parity (PPP) theory for 20 African countries using panel asymmetric nonlinear unit root test proposed by Emirmahmutoglu and Omay (2014), through the sequential panel selection method of Chortareas and Kapetanios (2009). While standard panel unit root tests fail to support the PPP, the empirical results from panel asymmetric nonlinear unit root test do support the PPP. However, additional tests reveal that support in all 20 African countries is mostly due to stationarity of the real effective exchange rates of Ghana and Rwanda where the adjustment process towards equilibrium is nonlinear and asymmetric.
This study examines whether the long-run purchasing power parity (PPP) holds in transition economies (Bulgaria, the Czech Republic, Hungary, Latvia, Lithuania, Poland, Romania and Russia) using monthly data over the 1995–2011 period. We apply a recently introduced panel stationary test, which accounts for sharp breaks and smooth shifts. The results indicate that the PPP holds only in two countries (i.e., Lithuania and Poland).
This study revisits Purchasing Power Parity theory (PPP) in the 34 OECD countries during January 1994-August 2013. We use a new panel stationary test with both sharp breaks and smooth shifts, a novel approach to panel unit-root testing, proposed by Bahmani-Oskooee et al. (2014). The results indicate that the PPP holds in half of the 34 OECD countries. These results indicate the importance of proper modelling of both sharp breaks and smooth shifts in real effective exchange rate series of OECD countries.
In this study, we apply the Panel Stationary test with both sharp and smooth breaks to test the validity of long-run purchasing power parity (PPP) for 20 African countries using quarterly data over the period 1971I–2012IV. Empirical results of Panel stationary tests with both sharp and smooth breaks indicate that PPP holds true for 10 out of these 20 African countries (i.e., Burkina Faso, Cameroon, Ghana, Kenya, Niger, Senegal, Seychelles, South Africa, Tanzania and Togo) studied.
Using a Markov Chain Monte Carlo algorithm, we show that the exchange rates of the Baht and of the Won are explained by the purchasing power parity theory when we incorporate the facts that these currencies were doubly truncated.
One of the macro variables that are included in most models is the exchange rate. Overall performance of a country’s exchange rate is measured by changes in nominal or real effective exchange rate (REER). These rates are constructed and published mostly for industrial countries by international organizations. Less developed countries have received little attention. In this article, the two rates are constructed for 21 African countries using quarterly data over the period 1971Q1–2012Q4. As an application, we use the REERs to show that even in Africa the movements of the real effective rates follow a nonlinear path.
This paper distinguishes exchange rate variability from exchange rate misalignments and presents statistical measures in this regard. It uses PPP as a crude approximation of equilibrium exchange rates and shows that during periods of possible misalignments, the exchange rate variability of some EMS and other currencies tends to increase.
The main purposes of this article are 3-fold. First, we construct measures of real and nominal effective exchange rates for 14 Middle East and North African countries over the 1970–2004 period. Second, we test the validity of the Purchasing Power Parity (PPP) by applying the ADF and KPSS tests to the real effective exchange rates. Finally, we employ the bounds testing approach to cointegration and error-correction modelling to show that nominal devaluation leads to real devaluation in the short-run as well as in the long-run in many of the countries.
This article applies recent developments in cointegration analysis with structural breaks and deterministic trends to analyse the relationship between the real Canada-US exchange rate and commodity prices. Previous empirical studies disagree on whether these variables are cointegrated. The root of disagreement could be in the handling of deterministic trends and potential structural breaks. I find that even after controlling for these matters, the question of whether the real exchange rate and commodity prices are cointegrated for Canada remains unresolved.
This paper utilizes the dynamic error-correction model (DECM) to examine the issue of purchasing power parity (PPP) for 11 developing countries (Argentina, Bolivia, Colombia, Cote d'Ivoire, Ecuador, Guatemala, Kenya, Nigeria, Peru, South Africa, and Venezuela). For comparison purposes, evidence from the traditional unit root methods of the augmented Dickey-Fuller (ADF) and Phillips-Perron is presented. The results from the conventional unit root tests failed to find evidence of PPP in all of the cases. However, the results from the generalized error-correction model detected evidence of PPP for nine out of the 11 countries under consideration. Based on these results, it was concluded that PPP holds in the long-run for the sample countries and that the implicit restrictions associated with unit root tests prevented earlier studies from finding evidence in support of PPP theory.
Several different approaches have been followed by researchers to test the validity of Purchasing Power Parity (PPP). Since the introduction of the unit-root tests, researchers have applied a battery of these tests to determine whether the real exchange rates are stationary. If the answer is in the affirmative, PPP is validated. While application of the standard augmented Dickey–Fuller test has not provided much support for PPP, a test that incorporates nonlinearity in the rates has. Under both tests, however, the null of nonstationary is tested against the alternative of stationarity. In this article, when we switch the null with the alternative and apply Kwiatkowski et al. (199235.
Kwiatkowski , D ,
Phillips , PCB ,
Schmidt , P and
Shin , Y . 1992. Testing the null hypothesis of stationarity against the alternative of a unit root. Journal of Econometrics, 54: 159–78. [CrossRef], [Web of Science ®]View all references) test, we provide relatively more support for the theory, getting closer and closer towards solving the PPP puzzle.
This paper attempts to provide evidence indicating that the Purchasing Power Parity (PPP) puzzle is becoming less of a puzzle. It present the results of Augmented Dickey-Fuller (ADF) test, nonlinear tests of nonstationarity, and Bayesian unit root tests, applied to ten SADC countries. The Bayesian tests were found to be biased in favour of a trend stationary model in all cases. It is argued that nonlinear approaches to exchange rate adjustments are likely to provide a firmer basis for inference and stronger support for the PPP in the long-term. This is more so at 1 per cent and 5 per cent levels of significance.
The real effective exchange rate is an index that is used to measure international competitiveness of a country. While the International Monetary Fund constructs and publishes the index for all industrial and some newly industrialized countries, the African nations receive no such attention. In this article we construct quarterly indexes of real and nominal effective exchange rates over the 1971I-2004III period for 21 African countries. We hope by publishing this data set, more research attention will be given to these countries. As an application, we test for the stationarity of the real effective rates to show that the Purchasing Power Parity theory holds only in four of our 21 cases.
We develop a new Markov Chain Monte Carlo procedure for a time series regression model truncated by upper and lower bounds. The regression error term is assumed to follow an ARMA--GARCH process. We use a convergence diagnostics with a simultaneous test of mean and covariance stationarity and discuss model selection criteria. Using MCMC procedure we test the purchasing power parity theory for the Japanese yen controlled to fluctuate in a narrow band and find that the theory is supported if double truncation is incorporated in estimation.
Some researchers, for example, Koop (1992), and Sims (1988), advocated for Bayesian alternatives to unit-root testing over the classical approach using the augmented Dickey-Fuller test (ADF). This paper studies what Koop (1992) called the 'Objective' Bayesian approach to unit-root testing. We apply the 'objective' Bayesian unit-root test to a study of long-run purchasing power parity (PPP) for the post-Bretton Woods era. While the classical approach using the ADF test cannot reject the unit-root hypothesis, the Bayesian approach, on the other hand, suggests that the unit-root hypothesis is not strongly supported by the sample data. Rather, the trend-stationary hypothesis receives the highest posterior probability in all cases except for the Japanese yen/German mark real exchange rate where the stationary hypothesis receives the highest posterior probability. In two Monte Carlo simulations, however, we find that the 'objective' Bayesian test have relatively low power in distinguishing between plausible alternatives, making it difficult to draw any conclusions concerning long-run PPP. We conclude that, at least for the 'objective' Bayesian test, the Bayesian approach is not necessary better than the classical ADF approach.
This paper contributes empirically to our understanding of informed traders. It analyzes traders' characteristics in a foreign exchange electronic limit order market via anonymous trader identities. We use six indicators of informed trading in a cross-sectional multivariate approach to identify traders with high price impact. More information is conveyed by those traders' trades which--simultaneously--use medium-sized orders (practice stealth trading), have large trading volume, are located in a financial center, trade early in the trading session, at times of wide spreads and when the order book is thin.
[eng] Transportation costs and monopoly location in presence of regional disparities. . This article aims at analysing the impact of the level of transportation costs on the location choice of a monopolist. We consider two asymmetric regions. The heterogeneity of space lies in both regional incomes and population sizes: the first region is endowed with wide income spreads allocated among few consumers whereas the second one is highly populated however not as wealthy. Among the results, we show that a low transportation costs induces the firm to exploit size effects through locating in the most populated region. Moreover, a small transport cost decrease may induce a net welfare loss, thus allowing for regional development policies which do not rely on inter-regional transportation infrastructures. cost decrease may induce a net welfare loss, thus allowing for regional development policies which do not rely on inter-regional transportation infrastructures. [fre] Cet article d�veloppe une statique comparative de l'impact de diff�rents sc�narios d'investissement (projet d'infrastructure conduisant � une baisse mod�r�e ou � une forte baisse du co�t de transport inter-r�gional) sur le choix de localisation d'une entreprise en situation de monopole, au sein d'un espace int�gr� compos� de deux r�gions aux populations et revenus h�t�rog�nes. La premi�re r�gion, faiblement peupl�e, pr�sente de fortes disparit�s de revenus, tandis que la seconde, plus homog�ne en termes de revenu, repr�sente un march� potentiel plus �tendu. On montre que l'h�t�rog�n�it� des revenus constitue la force dominante du mod�le lorsque le sc�nario d'investissement privil�gi� par les politiques publiques conduit � des gains substantiels du point de vue du co�t de transport entre les deux r�gions. L'effet de richesse, lorsqu'il est associ� � une forte disparit� des revenus, n'incite pas l'entreprise � exploiter son pouvoir de march� au d�triment de la r�gion l
This paper proposes new tests for detecting the presence of a unit root in quite general time series models. Our approach
is nonparametric with respect to nuisance parameters and thereby allows for a very wide class of weakly dependent and possibly
heterogeneously distributed data. The tests accommodate models with a fitted drift and a time trend so that they may be used
to discriminate between unit root nonstationarity and stationarity about a deterministic trend. The limiting distributions
of the statistics are obtained under both the unit root null and a sequence of local alternatives. The latter noncentral distribution
theory yields local asymptotic power functions for the tests and facilitates comparisons with alternative procedures due to
Dickey & Fuller. Simulations are reported on the performance of the new tests in finite samples.
Canada had a flexible exchange rate from October 2, 1950, to May 2, 1962. Many observers have commented on the stability of the Canadian exchange rate during this period and have discussed the significance of the Canadian experience for the general debate on fixed v. flexible exchange rates. The purpose of this article is not to enter this debate directly, but rather to document the facts on stability and to examine two possible reasons for it.
Using daily data on the US/Canadian exchange rate, measures of the stability of the rate are presented in section I. In section II tests of the hypothesis that speculators were a stabilizing force are conducted, and an affirmative conclusion reached. Finally, in section III the argument is made that much of the stability may have been a result of the generally parallel courses of the Canadian and United States economies in the years from 1950 to 1962.
Half Title Title Copyright Preface Contents Preface of the First Edition Preface of the Second Edition List of Principal Results
The use of a country's real effective exchange rate as a measure of external competitiveness implicitly assumes that, in the long run, purchasing power parity prevails between the country and its trading partners. A testable definition of long-run equilibrium existing among non-stationary time series is provided in the recently developed theory of co-integration. The existence of such a long-run “statistical equilibrium” between the U.S. inflation rate and an effective exchange-rate-adjusted inflation rate computed from its major trading partners is investigated in the paper.
This paper examines several grounds for doubting the value of much of the special attention recently devoted to unit root econometrics. Unit root hypotheses are less well connected to economic theory than is often suggested or assumed; distribution theory for tests of other hypotheses in models containing unit roots are less often affected by the presence of unit roots than has been widely recognized; and the Bayesian inferential theory for dynamic models is largely unaffected by the presence of unit roots. The paper displays an example to show that when Bayesian probability statements and classical marginal significance levels diverge as they do for unit root models, the marginal significance levels are misleading. The paper shows how to carry out Bayesian inference when discrete weight is given to the unit root null hypothesis in a univariate model.
We employ a Bayesian perspective to identify the type of prior needed to support the inference that most macroeconomic time series follow random walks. For many of the series considered by Nelson and Plosser (1982) the required prior involves assigning very low probability to trendstationary alternatives. When this prior is relaxed trend-stationarity is generally supported, thus the unit root inference seems inappropriate for these series: despite Nelson and Plosser's results indicating that macroeconomic time series are not inconsistent with the random walk hypothesis, our results indicate that for most series the trend-stationarity hypothesis is much more likely.
Several authors have urged that real and nominal exchange rates follow a random walk. Conditions under which the exchange rate follows a random walk are reviewed in this paper. Many of these do not appear to hold. Therefore, the empirical evidence presents a puzzle : some evidence suggets the exchange rate follows a random walk, while other evidence suggests the opposite should be true. This paper attempts to reconcile the evidence. It is argued that the tests for a random walk have low power. Monte Carlo evidence on four tests for a random walk, is presented that suppors this claim.
We reexamine long-run purchasing power parity (PPP) for the Dollar/Sterling exchange rate in the 1920s using a three-variable cointegration regression and the new statistics tabulated by Engle and Yoo (1987). Consistent with Taylor and McMahon's (1988) results, we reject cointegration for the Dollar/Sterling exchange rate, the U.K. and the U.S.A. price levels for the sample period February 1921 to May 1925. Contrary to Taylor and McMahon, however, we find only weak evidence of cointegration for the shorter sample period February 1921 to May 1924.
This paper reports on econometric tests of the hypothesis that purchasing power parity holds as a long-run relationship using data on eight industrialized countries during the flexible exchange rate period. The empirical work proceeds by (i) testing whether nominal exchange rates and relative price levels are co-integrated and (ii) conducting impulse response analysis of long-run exchange rate and relative price level changes. To explain the data, Keynesian models suggest that shocks during the estimation period were due principally to exogenous shifts in aggregate demand, while equilibrium models suggest that monetary factors have been relatively more important.
In this paper, the authors present evidence that neither large differences in inflation nor long time periods are necessary for a finding favorable to purchasing power parity. Evidence from cointegrating regressions and tests of the real exchange rate indicate that purchasing power parity held as a long-run constraint between the United States and Canada for the period 1950:10 to 1961:5. The authors also find that government intervention can distort purchasing power parity over a finite period. Once the data were extended beyond the period of the free float, the evidence is no longer favorable to purchasing power parity. Copyright 1991 by MIT Press.
Nonstationarity in the levels of spot exchange rates and domestic and foreign price indices makes the use of conventional tests of the absolute version of purchasing power parity (PPP) inappropriate. If PPP is true, inter-country commodity arbitrage ensures that deviations from a linear combination of spot exchange rates and domestic and foreign price levels should be stationary. Under these conditions, exchange rates and p rice levels should form a cointegrated system. We find the null hypothesis of noncointegration cannot be rejected for all five countries, thus violating the "long-run" absolute version of PPP.
This article presents evidence on mean reversion in industrial countries' real exchange rates in a setup that accounts naturally for cross-sectional dependence, is invariant to the benchmark currency and actually tests for the null of interest, i.e. purchasing power parity. Our results are based on the Kwiatkowski et al. (1992) test for the stationarity null generalized in a multivariate random walk plus noise model by Nyblom and Harvey (2000).
Using a new statistical test, this paper provides empirical evidence that the real exchange rate is not a random walk. If the real exchange rate were a random walk, deviations from purchasing power parity could be expected to become unbounded as the forecast horizon became longer. Recently, Christopher A. Sims proposed a test based on Bayesian posterior odds ratios that is designed to discriminate between a unit root and a large but stationary autocorrelation coefficient. This paper applies the Sims test to real exchange rate data for six industrial countries. The results reject the random walk hypothesis. Copyright 1992 by Ohio State University Press.
This paper utilizes cointegration analysis to examine purchasing power parity relationships over a long-time horizon. The results indicate that the exchange rate is cointegrated strongly with the wholesale price index ratio and somewhat weakly with the consumer price index ratio. The cointegrating coefficient between the exchange rate and the price ratio is close to one when cointegration is confirmed. The hypothesis that the real exchange rate follows a random walk is rejected in most cases. Finally, a new test for common trends finds no such common trends in exchange rates or price ratios. Copyright 1990 by Ohio State University Press.
Due to weaknesses in traditional tests a Bayesian approach is developed to investigate whether unit roots exist in macroeconomic time-series. Bayesian posterior odds comparing unit root models to stationary and trend-stationary alternatives are calculated using informative priors. Two classes of reference priors which are informative but require minimal subjective prior input are used. In this sense the Bayesian unit root tests developed here are objective. Bayesian procedures are carried out on the C. Nelson-C. Plosser (1982) and R. Shiller (1981) data sets as well as on generated data. The conclusion is that the failure of classical procedures to reject the unit root hypothesis is not necessarily proof that a unit root is present with high probability. Copyright 1992 by John Wiley & Sons, Ltd.
The concept of cointegration and the associated error-correction representation of a dynamic process (see R. F. Engle and C. W. G. Granger, 1987) is applied to the purchasing power parity relationship between Canada and the United States. The results are supportive of purchasing power parity as a long-run equilibrium relationship between the Canadian dollar/American dollar exchange rate. The purchasing power parity relationship is maintained, although with different dynamic mechanisms, during both fixed and flexible exchange rate regimes.
The relationship between cointegration and error correction models, first suggested by Granger, is here extended and used to develop estimation procedures, tests, and empirical examples. A vector of time series is said to be cointegrated with cointegrating vector a if each element is stationary only after differencing while linear combinations a8xt are themselves stationary. A representation theorem connects the moving average , autoregressive, and error correction representations for cointegrated systems. A simple but asymptotically efficient two-step estimator is proposed and applied. Tests for cointegration are suggested and examined by Monte Carlo simulation. A series of examples are presented. Copyright 1987 by The Econometric Society.
This paper presents an empirical analysis of long-run purchasing power parity (PPP) during the 1920s float, using recently developed methodology on the cointegration of economic time series. Our results are generally supportive of PPP as a long-run equilibrium condition on which exchange rates tended to converge over the period. For dollar-sterling, however, there is some evidence of a non-stationary drift away from fundamentals during the last year or so before Britain's return to the Gold Standard, perhaps due to speculation. Our results also appear to reconcile some apparently conflicting evidence in the literature.
This paper examines the behavior of forecasts made from a co-integrated system as introduced by Granger (1981), Granger and Weiss (1983) and Engle and Granger (1987). It is established that a multi-step forecast will satisfy the co-integrating relation exactly and that this particular linear combination of forecasts will have a finite limiting forecast error variance. A simulation study compares the multi-step forecast accuracy of unrestricted vector autoregression with the two-step estimation of the vector autoregression imposing the co-integration restriction.To test whether a system exhibits co-integration, the procedures introduced in Engle and Granger (1987) are extended to allow different sample sizes and numbers of variables.
In this paper we construct a model that describes the behavior of the foreign exchange market and Exchange Fund. Cross-spectral and regression analysis of daily data are used to show that official intervention contributed significantly to the short-run stability of Canadian exchange rates.
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