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Title:Getting PPP right: Identifying mean-reverting real exchange rates in panels PDF Logo
Authors:Chortareas, Georgios
Kapetanios, George
Issue Date:2008
Series/Report no.:Working Paper // School of Economics and Finance, Queen Mary, University of London 629
Abstract:Recent advances in testing for the validity of Purchasing Power Parity (PPP) focus on the time series properties of real exchange rates in panel frameworks. One weakness of such tests, however, is that they fail to inform the researcher as to which cross-section units are stationary. As a consequence, a reservation for PPP analyses based on such tests is that a small number of real exchange rates in a given panel may drive the results. In this paper we examine the PPP hypothesis focusing on the stationarity of the real exchange rates in up to 25 OECD countries. We introduce a methodology that when applied to a set of established panel-unit-root tests, allows the identification of the real exchange rates that are stationary. We apply procedures that account for cross-sectional dependence. Our results reveal evidence of mean-reversion that is significantly stronger as compared to that obtained by the existing literature, strengthening the case for PPP. Moreover, our approach can be used to provide half-lives estimates for the mean-reverting real exchange rates. We find that the half-lives are shorter than the literature consensus and therefore that the PPP puzzle is less pronounced than initially thought.
Subjects:PPP
panel unit root tests
real exchange rates
half-lives
PPP puzzle
JEL:C12
C15
C23
F31
Document Type:Working Paper
Appears in Collections:Working Paper Series, School of Economics and Finance, Queen Mary, University of London

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