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Title:A new solution to the purchasing power parity puzzles: Risk-aversion, exchange rate uncertainty and the law of one price PDF Logo
Authors:Arghyrou, Michael G.
Gregoriou, Andros
Pourpourides, Panayiotis M.
Issue Date:2009
Series/Report no.:Cardiff Economics Working Papers E2009/2
Abstract:We argue that even in perfectly frictionless markets risk aversion driven by exchange rate uncertainty may cause a wedge between the domestic and foreign price of a totally homogeneous good. We test our hypothesis using a natural experiment based on a unique micro-data set from a market with minimum imperfections. The empirical findings validate our hypothesis, as accounting for exchange rate uncertainty we are able to explain a substantial proportion of deviations from the law of one price. Overall, our analysis suggests the possibility of a new solution to the purchasing power parity puzzles.
Subjects:law of one price
purchasing power parity
risk aversion
exchange rate uncertainty
JEL:F31
F41
Document Type:Working Paper
Appears in Collections:Cardiff Economics Working Papers, Cardiff Business School, Cardiff University

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