Empirical test of purchasing power parity using a time-varying cointegration model for China and the UK

Jong Cheol Yoon, Dai Hong Min and Sang Young Jei

Physica A: Statistical Mechanics and its Applications, 2019, vol. 521, issue C, 41-47

Abstract: This study revisits purchasing power parity (PPP) for China and the United Kingdom (UK) by applying a time-varying cointegration model. When traditional linear unit root tests and a time-invariant cointegration test are performed, we find fixed long-run equilibrium in China and the UK. However, we cannot check the movement of the cointegration vector. To solve this limitation, we perform a time-varying cointegration. The result of a time-varying cointegration model shows that the validity of PPP for China varies over time. On the other hand, PPP does not hold for all periods for the UK. This study shows that the effect of government policy varies depending on the degree of openness. In China with a low degree of openness, export-oriented policies have had a positive impact on PPP. However, in the UK with a high degree of openness, PPP was not valid due to the role of the exchange rate as an asset price and the downward rigidity of wage.

Keywords: Purchasing power parity; Foreign exchange; A time-varying cointegration model; A time-invariant cointegration model (search for similar items in EconPapers)
JEL-codes: C22 F31 (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:phsmap:v:521:y:2019:i:c:p:41-47

DOI: 10.1016/j.physa.2019.01.072

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