Does the purchasing power parity theory still hold ? The UK as the case study

Kamran Ashraf and Abul Masih

MPRA Paper from University Library of Munich, Germany

Abstract: The purchasing power parity (PPP) theory is an integral part of international finance. The PPP examines the relationship between the inflation rate differential between two countries and their exchange rate movements. The purpose of this study is to investigate whether the PPP still holds or not. The UK is taken as a case study. The standard time series techniques are employed to address the issue. Our findings tend to indicate that the PPP theory does hold in the long run as evidenced in the cointegration (or comovement) of the exchange rate and price ratio variable. Furthermore, the Granger-causality analysis unveils that an exogenous shock to the US-UK exchange rate disturbs the long run equilibrium and the domestic-foreign price ratio variable bears the brunt of short-run adjustment to bring about the long run PPP equilibrium. The exchange rate is found to be the exogenous leading variable and the price ratio variable is found to play the role of a follower in terms of endogenous adjustment. The findings have strong policy implications for international trade and investment.

Keywords: exchange rate; domestic price; foreign price; cointegration; VECM; VDC (search for similar items in EconPapers)
JEL-codes: C22 C58 G15 (search for similar items in EconPapers)
Date: 2017-12-25
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://mpra.ub.uni-muenchen.de/100764/1/MPRA_paper_100764.pdf original version (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:100764

Access Statistics for this paper

More papers in MPRA Paper from University Library of Munich, Germany Ludwigstraße 33, D-80539 Munich, Germany. Contact information at EDIRC.
Bibliographic data for series maintained by Joachim Winter ().