A new solution to the purchasing power parity puzzles? Risk-aversion, exchange rate uncertainty and the law of one price: Insights from the market of online air-travel tickets

Michael Georgiou Arghyrou (), Andros Gregoriou () and Panayiotis M. Pourpourides ()

No E2009/2, Cardiff Economics Working Papers from Cardiff University, Cardiff Business School, Economics Section

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.

Keywords: Law of one price; purchasing power parity; risk aversion; exchange rate uncertainty (search for similar items in EconPapers)
JEL-codes: F31 F41 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-ifn, nep-opm and nep-upt
Date: 2009-01, Revised 2009-07
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Forthcoming in Canadian Journal of Economics

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