Uncover Latent PPP by Dynamic Factor Error Correction Model (DF-ECM) Approach: Evidence from five OECD countries

Duo Qin

No 2007-29, Economics Discussion Papers from Kiel Institute for the World Economy (IfW Kiel)

Abstract: This study explores a new modelling approach to bridge the gap between the bilateral setting of one ?domestic? economy facing one ?foreign? entity in theory and multilateral country data in reality. Under the approach, purchasing power parity (PPP) is embedded in latent disequilibrium factors, being extracted from a large set of bilateral price disparities; the factors are then used as error-correction leading indicators to explain exchange rate and inflation. Modelling experiments on five OECD countries using monthly data show promising results, which reverse the common belief that PPP is at best a very long-run relationship at the macro level.

Keywords: PPP; law of one price; dynamic factor; error correction (search for similar items in EconPapers)
JEL-codes: C22 C33 F31 (search for similar items in EconPapers)
Date: 2007
New Economics Papers: this item is included in nep-cba and nep-ifn
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http://www.economics-ejournal.org/economics/discussionpapers/2007-29
https://www.econstor.eu/bitstream/10419/17952/1/dp2007-29.pdf (application/pdf)

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Working Paper: Uncover Latent PPP by Dynamic Factor Error Correction Model (DF-ECM) Approach: Evidence from Five OECD Countries (2006)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:ifwedp:5734

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