PURCHASING POWER PARITY WITH RANK TESTS FOR NONLINEAR COINTEGRATION IN AFRICAN COUNTRIES

This study applies nonlinear cointegration to assess exchange rates with the corresponding relative prices and aggregate price levels for 20 African countries. We find that a nonparametric rank test has higher power than parametric testing procedures; a true data‐generating process of exchange rate is in fact a stationary nonlinear process. We examine the validity of purchasing power parity (PPP) from the nonparametric nonlinear point of view and provide robust evidence that clearly indicates PPP holds true for these countries. Hence, the long‐run African countries exchange rate adjustments are in equilibrium with the relevant fundamentals as suggested by the PPP hypothesis in a nonlinear way.     

Purchasing Power Parity under Regime Shifts: An Application to Asian Countries*

This paper re‐examines the long‐run purchasing power parity (PPP) relationship for nine Asian countries relative to the USA and Japan during a period containing significant structural breaks. The relevance of considering structural breaks in PPP tests is demonstrated by utilizing the Johansen et al. (2000) procedure that allows for up to two pre‐determined structural breaks. Using conventional tests without considering breaks, one is able to reject the null of no cointegration for only four countries. The Johansen et al. procedure clearly demonstrates the importance of allowing for structural breaks and provides strong support for long‐run PPP for all the countries, regardless of the base country, except in the case of the Philippines vis‐à‐vis Japan. The Hansen–Johansen parameter constancy test indicates stability for all the countries except the Philippines relative to the USA and Malaysia relative to Japan.     

Purchasing Power Parity in South East Asian Countries Economies: A Cointegration Approach

This paper presents findings from a study of the long-run purchasing power parity (PPP) conditions in five Asian economies. The cointegration tests using exchange rates and price indices from end-of-quarter observations over the last twenty years reject the PPP proposition for all countries. The absolute version of the PPP hypothesis is tested next by using lower frequency, that is, semi-annual and annual, data. In general these tests also failed to support the long-run PPP hypothesis. Further analysis using the Johansen-Juselius (1990) multivariate approach also failed to support the hypothesis.     

DO AFRICAN COUNTRIES MOVE ASYMMETRICALLY TOWARDS PURCHASING POWER PARITY?

This paper investigates the possibility that the adjustment towards long‐run relative purchasing power parity (PPP) is dependent upon the nature of deviations from PPP that are experienced. While existing studies involving developed and less developed countries often find against PPP having employed linear tests of non‐stationarity or non‐cointegration, we employ a new cointegration test, recently advocated by Enders and Siklos and Enders and Dibooglu, that tests for an asymmetric adjustment towards parity with respect to positive and negative deviations of the real exchange rate from its equilibrium value. Using a sample often African economies with data taken from the post‐Bretton Woods floating exchange rate era, long‐run PPP holds in eight of these cases if an explicit distinction is made between positive and negative deviations. Across the sample, we find variation in the type of asymmetry experienced and the roles played by price and nominal exchange rate adjustment.     

Testing purchasing power parity for Japan and the US: A structural-break approach

In this work we empirically assess the weak and strong forms of purchasing power parity (PPP) hypothesis for the economies of Japan and US. Monthly data for the, traded-goods price indices and the JPY/USD exchange rate are employed for the, period from January 2000 to October 2012. This period includes large shocks, such as, the US subprime crisis and the 2011 Tsunami in Japan. We take into account possible, structural shifts and breaks by employing the class of Lee and Strazicich, 2003, Lee and Strazicich, 2004 unit, root tests. Empirical analysis suggests that a break corresponding to the start of the US subprime crisis is not rejected. Furthermore, utilizing the Gregory and Hansen (1996) and, Hatemi (2008) cointegration methodologies, the weak form of PPP is not rejected. We, also test the strong PPP hypothesis by using Dynamic Ordinary Least Squares, (DOLS). The empirical evidence rejects the strong form of PPP for the period, preceding the US subprime crisis in contrast to the period after.     

Long-Run Purchasing Power Parity with Asymmetric Adjustment

Tests of purchasing power parity (PPP) that use panel data are more supportive of the theory than are bilateral tests. The article uses threshold cointegration to explore long-run PPP. Using data from the post-Bretton Woods period, we show that cointegration with threshold adjustment holds for a number of European countries on a bilateral basis. Focusing on France and Germany as base countries, we show that the error-correction model has important nonlinear characteristics in that prices and the exchange rate have markedly different adjustment patterns for positive gaps from PPP than negative gaps.     

Is the Gulf Cooperation Council an Optimum Currency Area?

This article applies the theory of Generalized Purchasing Power Parity (G‐PPP) to assess the potential for an optimum currency area (OCA) for the Gulf Cooperation Council (GCC) countries over the period 1973–2009. Utilizing a multivariate cointegration procedure that allows for up to two predetermined structural breaks, the results suggest that the GCC countries could form an OCA since macroeconomic conditions are in favor of forming an OCA, i.e., real exchange rates share common trends and the parameter stability test indicates that the G‐PPP relationship has been stable for the period analyzed. Moreover, the results suggest that the withdrawal of Oman and/or United Arab Emirates (UAE) from the union has no impact on forming the union. However, based on other OCA criteria, the results suggest that the OCA may be challenged.     

Food prices and long-run purchasing power parity in Africa

The purchasing power parity (PPP) theory is a cornerstone of exchange rate models in international economics. PPP is very important for two main reasons: first, it can serve as a prediction model for exchange rates, and second, it can serve as a benchmark in judging the level of exchange rate movements. This article utilised the Johansen cointegration technique in examining whether or not there is empirical support for long-run PPP in Africa. Annual data were used for exchange rates and food price indices in 25 countries covering the 1958-97 period. The empirical evidence showed strong support for long-run PPP in Africa, thereby providing wider acceptance for the applicability of PPP in exchange rate and other macroeconomic adjustment policies.     

Do Real Exchange Rates Follow a Nonlinear Mean Reverting Process in Developing Countries?

In an effort to fight relatively high inflation, many developing countries try to manage their nominal exchange rates through official intervention. In addition, developing countries tend to have high transportation costs, tariffs, and nontariff barriers. These factors are among the sources of generating nonlinearity in real exchange rates and hence some nonlinear adjustment toward purchasing power parity (PPP) in developing countries. In this paper, we employ monthly real effective exchange rate (REER) data of 88 developing countries and test the null of nonstationarity versus an alternative of linear stationarity by the means of a conventional unit root test and compare the results with those obtained from a new test in which the null is the same but the alternative hypothesis is nonlinear stationarity. The latter test supports the PPP theory in more developing countries compared with the former test, suggesting that nonlinear adjustment toward PPP in developing countries is an important phenomenon. Reported country characterizations indicate that reversion in REER occurs more often for high-inflation countries and for countries with high flexibility in their exchange rates.     

The effects of inflation on the predictability of price changes in Latin America: Some estimates and policy implications

This paper argues that the relationship between price variability and inflation in high-inflation countries should be estimated on a frequent basis and that rational expectations are the appropriate formulation for predicting inflation. Analysis of seven Latin American countries, taking these factors into account, suggests that higher inflation contributes to the difficulty of predicting price changes. The impact is more moderate than that found in previous studies, however, indicating that less concern may be warranted about the possible stagflationary effects of expansionary policies.     

Real Exchange Rate Dynamics in the Asian Economies: Can Regime Shifts Explain Purchasing Power Parity Puzzles?

Abstract

We show that the strong version of the purchasing power parity (PPP) hypothesis holds in most of the US dollar real exchange rates using cointegration method that accounts for breaks in the models. The break dates in seven of the Asian currencies coincide with the two rounds of currency depreciation recorded during the 1997–1998 financial crises. We obtain a mean half-life estimate of about 10 months for PPP to converge to its long-run equilibrium level. Our confidence intervals based on persistence profile approach for the half-lives is much narrower than previous evidence might indicate. Taken together, these results show that mean reversion is stronger than commonly thought.     

Revisiting long-run purchasing power parity with asymmetric adjustment for G-7 countries

In this study, we applied a threshold cointegration test advanced by Enders and Siklos (2001) to investigate the properties of asymmetric adjustment on long-run purchasing power parity (PPP) in G-7 countries between January 1994 and April 2010. Although there was strong evidence of long-run PPP for these G-7 countries, with the exception of Canada, the adjustment mechanism was asymmetric. These results have important policy implications for G-7 countries.     

Cointegration Tests of Purchasing Power Parity: the Case of the Thai Baht*

This paper will examine the validity of the purchasing power parity (PPP) hypothesis for the Thai baht vis-à-vis the currencies of Thailand's key trading partners under the new exchange rate regime using the cointegration technique. The major conclusions obtained from this empirical analysis may be broadly summarized as follows. First, the empirical evidence, based on the DF and ADF statistics, seems to suggest that the nominal exchange rates and relative prices are well characterized as non-stationary I(1) processes. Second, the cointegration analysis provides no evidence in support of a long-run equilibrium relationship between bilateral nominal exchange rates for the Thai baht vis-à-vis the currencies of Thailand's major trading partners and the corresponding relative price ratios. This implies rejection of PPP for these countries. If this is the case, considerable care should be taken in assessing the long-run implications for the real exchange rate, and thus competitiveness against Thailand's key trading partners, of shocks to the nominal exchange rate.     

Purchasing power parity in transition countries: Old wine with new bottle

This study questions whether the long-run purchasing power parity (PPP) holds in the transition economies (Bulgaria, the Czech Republic, Hungary, Latvia, Lithuania, Poland, Romanian, and Russia) for the period from January 1995 to October 2011. We employ the Sequential Panel Selection Method (SPSM) procedure using the Panel KSS unit root test with a Fourier function, a novel approach to panel unit root testing. The SPSM approach classifies the whole panel into a group of stationary and non-stationary series and is able to account for structural breaks, nonlinearity, and cross-section dependence. The results indicate that the PPP holds true for more than half of these transition countries studied, with the exception of Hungarian, the Czech Republic and the Russia. The findings have important policy implications for the transition countries.     

Purchasing Power Parity Between the UK and Germany: The Euro Era

We use the Johansen cointegration approach to assess the empirical validity of the purchasing power parity (PPP) between the UK and Germany since the introduction of the euro. We conduct the empirical analysis in the context of the global financial crisis that began in 2007 and find that it directly affects the cointegration space. We fail to validate the Johansen and Juselius (1992) original hypothesis that nonstationarity of PPP associates with the nonstationarity of interest rate differentials to produce a stationary relation. On the other hand, we do not reject PPP. We find that PPP cointegrates with inflation differentials. We also find, contrary to conventional wisdom, that (i) equilibrium adjustment occurs between the German and UK inflation rates, while weak exogeneity exists for the German and UK interest rates and the PPP condition, and (ii) three common trends associated with the German interest rate the UK interest rate, and the PPP condition “push” the system with the German interest rate and the PPP condition playing dominant roles in affecting inflation in both Germany and the UK. These results cast serious doubt on the presumed independence of the UK monetary policy.     

Analyzing Heterogeneous Stock Price Comovements Through Hybrid Approaches

This paper studies the hypothesis of stock price comovements between the US market and four different regions (the G6, the BRICS, the MENA (Middle East North Africa) during calm and crisis periods. Using different econometric approaches (BEKK-GARCH model, cointegration tests, and panel cointegration tests), we checked the interdependence of these markets in the short and the long term. Our findings point to the importance of heterogeneity linked to the stock price adjustment process, inviting individual analysis to be carried out according to market specificities in the aim of identifying countries that are sources of investment opportunities. We also highlighted the presence of time-varying stock price comovements that significantly increased after the subprime crisis. This enabled us to specify periods and regions that can still provide promising diversification benefits. Investigation of this issue is of interest for investors and bankers in order to improve their portfolio choices, diversification strategies as well as risk management.     

Cointegration tests of purchasing power parity

Im et al. (Unpublished working paper, 2008) develop cointegration tests using stationary instrumental variables. Their tests avoid the need to simulate critical values for the cointegration estimations, especially problematic in the presence of a nuisance parameter. Likewise, bootstrapping errors is unnecessary. Using an updated version of the Taylor (Rev Econ Stat 84(1):139–150, 2002) data set, the Im et al. (Unpublished working paper, 2008) approach is applied to two well-known, single equation cointegration methods to test for purchasing power parity. The estimations with instruments provide evidence of purchasing power parity (PPP) for more than half of the countries studied; but the empirical results, hence conclusions regarding PPP sometimes differ with the choice of instrument.     

Purchasing Power Parity: Error Correction Models and Structural Breaks

This paper examines purchasing power parity (PPP) behavior using error correction models (ECM) and allowing for structural breaks. We distinguish four different objectives: first, this paper examines which variable or variables (the exchange rate and/or international relative prices) exhibit a significant error correction mechanism. Second, this paper presents empirical evidence about the adjustment velocity to the long-run equilibrium. Third, it examines the evidence regarding cointegration and the adjustment coefficients parameter instability, and finally, it analyzes whether traded and non-traded sectors exhibit different behavior. The most important results are: (1) the predominant adjustment is in the exchange rate with a larger velocity adjustment than in relative prices; (2) the evidence suggests that when there are strong depreciations or appreciations in the exchange rate, the international relative prices adjust (i.e., there is evidence of pass-through); (3) the dynamic adjustment to equilibrium is, in general, stable.     

Generalized purchasing power parity and the case of the European Union as a successful currency area

This article uses multicountry purchasing power parity (PPP) tests to study the success of the European monetary system (EMS) in creating a successful currency area for a stable European monetary union. If the EMS has sufficiently integrated the fundamentals within the European Union, then real exchange rates between member countries will share a common stationary trend when denominated by a common outside currency. Previous research using two-country PPP tests have been inadequate in explaining the nonstationary nature of real exchange rates between the EMS countries and nonmember countries. The use of generalized PPP tests can show that even though individual exchange rates within the EMS may appear to be nonstationary with respect to outside countries, some of them will combine to form a currency union with a stable stationary trend.