Revisiting Purchasing Power Parity for 15 Latin American Countries: Threshold Unit Root Test

Abstract

This study applies the threshold unit root test proposed by Caner and Hansen (2001) to test the validity of long-run purchasing power parity (PPP) in a sample of 15 Latin American countries. These countries share characteristics as high inflation, nominal shocks and trade openness which might have led to quicker adjustment in relative prices and contributed for PPP to hold. The empirical results indicate that most of the real exchange rates in these 15 Latin American countries adjustments are in equilibrium with the relevant fundamentals behaving like a nonlinear process, characterized by a unit root process. These results provide support for PPP for only six of these 15 Latin American countries under study, and the governments of these countries can use PPP to predict exchange rate that determines whether a currency is over or undervalued and experiencing difference between domestic and foreign inflation rates.