Threshold effects in purchasing power parity for African Countries

Abstract

This study applies non-linear threshold unit-root test to assess the non-stationary properties of the real exchange rate for twenty African countries. We found that non-linear threshold unit-root test has higher power than linear method. As suggested by Caner and Hansen (2001), the true data generating process of exchange rate is a stationary non-linear process. We examine the validity of PPP from the non-linear point of view and provide robust evidence clearly indicating that purchasing power parity (PPP) holds true for six countries, namely; Egypt, Ethiopia, Gambia, Malawi, Seychelles and South Africa. Our findings point out their exchange rate adjustment is mean reversion towards PPP equilibrium values in a non-linear way.