Pitfalls in panel tests of purchasing power parity

Anker, Peter

doi:10.1007/bf02707334

Cited by 12 publications

(5 citation statements)

References 18 publications

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“…The majority of empirical papers seem to support the PPP (e.g. Oh (1996); Papell (1997); Coakley and Fuertes (1997); Taylor and Sarno (1998); Anker (1999); Papell and Theodoridis (2001)), although some other studies cast doubts on the existence of a PPP relation ( Frankel and Rose , 1996; O'Connell , 1998; Boyd and Smith , 1999). As demonstrated by O'Connell (1998) and Wu and Wu (2001), an important problem with many early studies is the cross‐country correlation that leads to an over‐rejection of the unit root hypothesis.…”

Section: Empirical Illustrationmentioning

confidence: 99%

Panel unit root tests under cross‐sectional dependence

Breitung

Das

2005

Statistica Neerlandica

580

342

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In this paper alternative approaches for testing the unit root hypothesis in panel data are considered. First, a robust version of the Dickey-Fuller t-statistic under contemporaneous correlated errors is suggested. Second, the GLS t-statistic is considered, which is based on the t-statistic of the transformed model. The asymptotic power of both tests is compared against a sequence of local alternatives. To adjust for short-run serial correlation of the errors, we propose a pre-whitening procedure that yields a test statistic with a standard normal limiting distribution as N and T tends to infinity. The test procedure is further generalized to accommodate individual specific intercepts or linear time trends. From our Monte Carlo simulations it turns out that the robust OLS t-statistic performs well with respect to size and power, whereas the GLS t-statistic may suffer from severe size distortions in small and moderate sample sizes. The tests are applied to test for a unit root in real exchange rates.

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Section: Empirical Illustrationmentioning

confidence: 99%

Panel unit root tests under cross‐sectional dependence

Breitung

Das

2005

Statistica Neerlandica

580

342

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“…Likewise, evidence based on panel data sets is more in favour of the PPP hypothesis (see, for instance, Anker (1999)). …”

Section: Ecb Working Paper Series No 682mentioning

confidence: 99%

Is reversion to PPP in euro exchange rates non-linear?

Schnatz

2007

IEEP

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Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Non-technical summary Terms of use: Documents in EconStor mayThe wide fluctuations in the euro exchange rate since its launch in 1999 call for a deeper understanding of the underlying relationships. From a policy perspective, it is particularly useful to understand of whether and when exchange rate changes constitute movements towards or away from some long-term equilibrium level. While there are various ways to think about equilibrium exchange rates, this paper focuses on the universal starting point of applied exchange rate analysis which is to compare the current exchange rate against some measure of purchasing power parity (PPP). In its relative version, PPP states that nominal exchange rates move in proportion to relative developments in domestic and foreign prices implying a constant real exchange rate. While visual inspection seems to support that the euro real exchange rates oscillate around a mean in the long run, more rigorous statistical tests commonly fail to confirm such mean reverting properties.This finding should not lead us to the conclusion to discard drawing inferences from PPP analysis. Several caveats caution against a too strict interpretation of such tests of PPP. These include the lack of power of the tests themselves, the real exchange rate interaction with economic fundamentals (such as different trends in productivity) and the presence of nonlinearities in the mean reversion process. This paper investigates the latter aspect.Non-linearities in the adjustment of exchange rates can be justified from both a goods and a financial market perspective. As international goods arbitrage involves transaction costs, arbitrage sets in once the real exchange rate protractedly moves outside certain limits. From an asset market perspective, differing trading strategies could play a role with "Chartists" dominating market dynamics when the exchange rate is close to some perceived equilibrium, while "Fundamentalists" being at play once the exchange rate is increasingly misaligned.Appling this concept to the euro, the presence of such non-linear behaviour is confirmed for the real effective exchange rate of the euro and the two bilateral euro exchange rates with the biggest weight in the euro effective exchange rate, namely the real euro-dollar and the real euro-pound sterling exchange rates. Specifically, using a smooth transition autoregressive (STAR-) model, we find that the further away the real exchange rate moves from PPP, the stronger th...

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“…The literature examining this hypothesis is extensive. Froot and Rogoff (1995), Taylor and Sarno (1998), O'Connell (1998), Anker (1999), and Breitung and Candelon (2005) have presented the theoretical background and empirical evidence of the PPP-real exchange rates relationship. Froot and Rogoff (1995) found that the real exchange rate is stationary over sufficiently long horizons.…”

Section: Introductionmentioning

confidence: 99%

“…Taylor and Sarno (1998), found that the real exchange rates among the G5 are CPI-adjusted, which means that the exchange rates are apparently mean reverting over the floating rate period. O'Connell (1998) and Anker (1999) emphasized controlling the cross-sectional dependence in case of investigating the random walk effect of the panel data of real exchange rates. Breitung and Candelon (2005) considered structural breaks and found that the PPP hypothesis holds in the Asian countries, which experienced a flexible exchange rate; on the contrary, the South and Latin American currencies, which are in the pegged regime for a long time, do not hold the PPP hypothesis.…”

Section: Introductionmentioning

confidence: 99%

The ASEAN experience of the purchasing power parity theory

Murad

Hossain

2018

Financ Innov

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We used panel data analysis to evaluate the relative purchasing power parity (PPP) hypothesis of the ten ASEAN member countries between 1973 and 2015. We incorporated the cross-sectionally augmented panel unit root test as proposed by Pesaran (J Appl Econ 22:265-312, 2007). For panel cointegration analysis, we employed the four error-correction-based Westerlund (Oxf Bull Econ Stat 69:709-748, 2007) panel cointegration tests. The Westerlund (Oxf Bull Econ Stat 69:709-748, 2007) tests are general enough to permit a large degree of heterogeneity, both in the long-run cointegrating relationship and in the short-run dynamics, and dependence within as well as across the cross-sectional units. To check the robustness of the results, we further estimated the cointegration test excluding Indonesia and Brunei. The findings support our initial results. Further, all the results overwhelmingly support the relative PPP hypothesis. Consequently, the monetary authority would be able to implement a self-regulating monetary policy. It would also be able to control the exchange rates.

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Pitfalls in panel tests of purchasing power parity

Abstract: F31,

Cited by 12 publications

References 18 publications

Panel unit root tests under cross‐sectional dependence

Panel unit root tests under cross‐sectional dependence

Is reversion to PPP in euro exchange rates non-linear?

The ASEAN experience of the purchasing power parity theory

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