Money shocks and deviations from purchasing power parity

This paper applies the island-economy framework of Phelps (1970) to a small open economy under a flexible exchange rate to study the effects of nominal (and real) disturbances on the purchasing power parity relation. Incomplete information about the aggregate state of the economy (and informational differences between agents) implies that a monetary shock that has finite variance can induce deviations from purchasing power parity while also affecting production, consumption and the current account. The real effects of money, however, become smaller as the variance of money gets larger. A type of ‘Lucas slope effect’ of money on deviations from purchasing power parity is obtained.     

Relative price changes and deviations from purchasing power parity

During recent years, exchange rate fluctuations have exceeded variation in price indices. As a result, a number of theories have been developed to explain the apparent ‘overshooting’ of the exchange rate. The purpose of this paper is to argue that such elaborate extensions may be unnecessary, because the law of one price is more robust than previously believed. In particular, it can be shown that the law of one price is consistent with the observed variability of exchange rates and that it outperforms the overshooting models in explaining the stochastic behavior of exchange rates and interest rates.     

Measuring the persistence of deviations from purchasing power parity with a fractionally integrated STAR model

Empirically, elements of both fractional long memory and threshold non-linearity are present in the real exchange rates of the G-7 countries against the US, notably in the EU countries. Estimated half lives of deviations from PPP using median unbiased corrections to conventional linear autoregressive models corroborate existing evidence related to the PPP paradox as half lives range from at least four years to an infinite number of years. In contrast, for each EU country, accounting for threshold non-linearity results in estimated half lives that can be less than three years even with the allowance for fractional long memory.     

Temporal aggregation and purchasing power parity persistence

This paper uses a unique new monthly US-UK real exchange rate series for the January 1794-December 2009 period to reexamine the academic debate over purchasing power parity (PPP). The consensus view described by Rogoff (1996) is that PPP holds in the long-run, but short-run deviations are very persistent, with half-lives ranging from 3 to 5 years. Most of the literature using long time series relies on the annual data developed by Lee (1976) and Lothian and Taylor (1996), which were both constructed from underlying higher-frequency data sources. Estimates of purchasing power parity persistence using these series may therefore be subject to temporal aggregation bias. We find evidence of aggregation bias which indicates the half-life of PPP deviations has been overestimated in much of the previous literature. We also find that estimates of the half-lives are further reduced once we account for the Harrod (1933)-Balassa (1964)-Samuelson (1964) effect. The result of aggregation bias appears to be robust even when considering the case that real exchange rates exhibit nonlinear dynamics.     

Static deviations from purchasing-power parity

The paper examines the ‘real’ effects of monetary policy in a small open economy in full stock-flow equilibrium. In the presence of government debt, an increase in the money supply generally produces deviations from purchasing power parity. Money creation through foreign-exchange purchases results in an overvaluation of the domestic currency. While its short-run effects favor the export industries, its long-run effects are thus in favor of the domestic sector. The same is true for open-market purchases, but the overvaluation is probably smaller in this case.     

A re-examination on dissecting the purchasing power parity puzzle

The purpose of this paper is to examine the source of a real exchange-rate adjustment based on the impulse-response function constructed from local projections when the true data-generating process (DGP) is unknown. This work extends the local-projection method proposed by Jordà [2005. Estimation and inference of impulse responses by local projections. American Economic Review 95, 161-182] to allow for variables that are I(1) and exhibit cointegration. Our paper shows that nominal exchange-rate adjustments dominate in the reversion toward PPP regardless of a nominal exchange-rate shock or a price shock. It is also shown that the half-life of real exchange rates is close to that of nominal exchange rates. Since these results are consistent with those of Cheung et al. [Cheung, Y.W., Lai, K.S., Bergman, M., 2004. Dissecting the PPP puzzle: the unconventional roles of nominal exchange rate and price adjustments. Journal of International Economics 64, 135-150], we therefore conclude that their main findings are robust to possible misspecifications in the true DGP.     

A century of purchasing power parity confirmed: The role of nonlinearity

Taylor (2002) claims that Purchasing Power Parity (PPP) has held over the 20th century based on strong evidence of stationary for century-long real exchange rates for 20 countries. Lopez et al. (2005), however, found much weaker evidence of PPP with alternative lag selection methods. We reevaluate Taylor’s claim by implementing a recently developed nonlinear unit root test by Park and Shintani (2005). We find strong evidence of nonlinear mean-reversion in real exchange rates that confirms Taylor’s claim. We also find a possible misspecification problem in using the ESTAR model that may not be detected with Taylor-approximation based tests.     

Why panel tests of purchasing power parity should allow for heterogeneous mean reversion

Recent studies of purchasing power parity (PPP) use panel tests that fail to take into account heterogeneity in the speed of mean reversion across real exchange rates. In contrast to several other severe restrictions of panel models and tests of PPP, the assumption of homogeneous mean reversion is still widely used and its consequences are virtually unexplored. This paper analyzes the properties of homogeneous and heterogeneous panel unit root testing methodologies. Using Monte Carlo simulation, we uncover important adverse properties of the panel approach that relies on homogeneous estimation and testing. More specifically, power functions are low and assume irregular shapes. Furthermore, homogeneous estimates of the mean reversion parameters exhibit potentially large biases. These properties can lead to misleading inferences on the validity of PPP. Our findings highlight the importance of allowing for heterogeneous estimation when testing for a unit root in panels of real exchange rates.     

Beyond the purchasing power parity: testing for cointegration and causality between exchange rates, prices, and interest rates

This paper reexamines the causality between the dollar and the yen in a multivariate framework with the aid of cointegration and error-correcting modeling for the 1951–94 period. The Phillips-Perron tests and Johansen's tests are performed. While causality from interest rates to exchange rates is found in the short run, no causality between prices and exchange rates is found in the short run. However, causality is found running from relative prices to exchange rates along with interest rates between the U.S. and Japan in the long run, which supports the long-run PPP hypothesis.     

Purchasing power parity, unit roots, and dynamic structure

Recent studies of purchasing power parity (PPP) account for the possible presence of unit roots in nominal exchange rates and relative price indices by applying standard unit-root tests to real exchange rates, which are ratios of nominal exchange rates and relative price indices. These studies occasionally find evidence of PPP, but as a whole, the evidence is not definitive. Standard unit-root tests impose a restrictive dynamic structure between nominal exchange rates and relative price indices. I specify and estimate a generalized dynamic structure. I reject the dynamic restrictions implicit in standard unit-root tests of PPP, and find stronger evidence of PPP than do most other recent studies.     

Valuation ratios and price deviations from fundamentals

This paper sheds light on US stock price deviations from fundamentals by analyzing the time-series dynamics of post-1870 S&P valuation ratios. It employs a non-linear, two-regime framework that allows for different behavior over phases of the stock market cycle. Persistence in the ratios implies prolonged price deviations from fundamentals stemming from short run continuation fueled by investor sentiment during bull markets. However, the pull from fundamentals ensures that valuation ratios and prices move toward their equilibrium levels in bear markets. Impulse response functions highlight sluggish adjustment and indicate that the effects of positive shocks are more pronounced and long-lasting in bull markets. The main conclusion is that, while market sentiment plays an important transitory role, valuation ratios do mean revert and so prices reflect fundamentals in the long run.     

Product market pricing power, industry concentration and analysts’ earnings forecasts

This is the first study to establish a link between product market power and analysts’ earnings forecast accuracy and bias. Relating two different dimensions of market power to earnings forecastability, we document that (a) a firm’s relative pricing power and (b) its industry concentration are strong positive determinants of analysts’ earnings forecast accuracy. We find that forecasting earnings of higher market power firms is less complex due to their ability to withstand cost shocks as well as greater informational-efficiency enjoyed by such firms. Further, forecast optimism increases with weakening product market pricing power and with lower industry concentration. The knowledge derived from this study will hopefully improve the accuracy of equity valuation, and thereby engender better buy-side (stock selections) and sell-side recommendations by analysts. Our analysis also suggests that brokerage firms compensating analysts based on forecast accuracy need to adjust for the differential in the information complexity of different industries.     

Uncovered interest parity, monetary policy and time-varying risk premia

In a recent paper, McCallum argued that monetary-policy behavior can be responsible for the apparent empirical failure of uncovered interest parity (UIP). The present paper investigates whether optimizing policy behavior can account for the observed regime-dependence of UIP evidence. The main result is that the tradeoff between interest-rate and exchange-rate stability is a potential candidate for the explanation of the apparent failure of UIP and that the consideration of policy reactions can explain why deviations from UIP differ systematically by the exchange-rate regime.     

Short-run deviations and time-varying hedge ratios: Evidence from agricultural futures markets

This paper investigates the hedging effectiveness of time-varying hedge ratios in the agricultural commodities futures markets using four different versions of the GARCH models. The GARCH models applied are the standard bivariate GARCH, the bivariate BEKK GARCH, the bivariate GARCH-X and the bivariate BEKK GARCH-X. Futures data for corn, coffee, wheat, sugar, soybeans, live cattle and hogs are applied. Comparison of the hedging effectiveness is done for the within sample period (1980–2004), and two out-of-sample periods (2002–2004 and 2003–2004). Results indicate superior performance of the portfolios based on the GARCH-X model estimated hedge ratio during all periods.     

Deviations from daily uncovered interest rate parity and the role of intervention

This paper considers the relationship between daily deviations from uncovered interest rate parity and US and German central bank intervention. The study uses daily overnight Eurocurrency deposit rates with a maturity time of 1 day, which exactly matches the sampling interval of the data. The intervention data are the official net daily purchases and sales of dollars vis-à-vis the German mark by the Federal Reserve System and the Bundesbank. The model uses FIGARCH innovations to represent the degree of long-term dependence in the volatility process. Some support is found for the intervention variables affecting the risk premium as predicted by theory. The impact of intervention in the 2 years immediately following the meltdown of the equity markets in October 1987 and Louvre Accord is particularly strong.     

Industry and time specific deviations from fundamental values in a random coefficient model

The paper analyzes the relationship between stock prices and fundamentals for a large sample of US stocks in the last 10 years using a random coefficient model. Heterogeneity and omitted variable bias are properly taken into account with model coefficients being allowed to vary across time and industries. The random coefficient model allows to track waves of reliance on analysts’ forecasts and nonfundamental stock price components across time and clearly identifies the growth of the nonfundamental component in the long 1991–2000 swing.      

Trade, autonomy and perestroika

On 19–20 May 1989 in London The Other Economic Summit (TOES) conference questioned the justice and efficiency, as well as the environmental consequences, of current enthu iasm for ‘free trade’, and for economic growth measured by GNP, the extension of the money economy and the rise of corporate, multinational business power.     

Liquidity,ownership concentration,corporate governance,and firm value: Evidence from Thailand

We examine the interactions among ownership structure, liquidity, and corporate governance in an important emerging market. The results suggest that firms with more concentrated ownership experience significantly lower stock liquidity. Large shareholders are assumed to possess private information, leading to information asymmetry and thus a higher adverse selection cost. As a result, higher ownership concentration is associated with less liquidity. Nevertheless, there is no evidence that corporate governance plays a significant role in the relationship between ownership and liquidity in Thailand.