 Real exchange rates and time-varying trade costsEfthymios Pavlidis, Ivan Paya () and David Peel Journal of International Money and Finance, 2011, vol. 30, issue 6, 1157-1179 Abstract: This paper re-examines the empirical modeling of Purchasing Power Parity (PPP) deviations in the presence of commodity market frictions. First, we show that a specific type of smooth transition models can closely approximate the functional form of the theoretical adjustment mechanism derived by Dumas (1992) [Dynamic Equilibrium and the Real Exchange Rate in a Spatially Separated World, Review of Financial Studies,5:2153-180] for the case of constant as well as changing trade costs. Second, we develop, for the first time, an empirical model of the real exchange rate which allows for changes in the degree of market integration. By employing a long span of data on the Dollar-Sterling real exchange rate and a micro-founded proxy for trade frictions, we provide novel evidence of a significant relationship between the persistence of the real exchange rate and the level of trade costs. This finding suggests that both the difficulty of detecting PPP and the extend of Rogoff's puzzle vary over time with the degree of trade restrictiveness. Finally, we highlight policy repercussions of our results. Keywords: Purchasing; power; parity; Trade; frictions; Smooth; transition; nonlinearity; Gravity; model; of; trade (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:30:y:2011:i:6:p:1157-1179 Access Statistics for this article Journal of International Money and Finance is currently edited by J. R. Lothian More articles in Journal of International Money and Finance from Elsevier |
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