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Purchasing power parity: three stakes through the heart of the unit root null

Matthew Higgins () and Egon Zakrajsek ()

No 2000-22, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (US)

Abstract: We provide a comprehensive analysis of the purchasing power parity hypothesis, relying on a linear panel data framework. First, we consider two panel unit root tests, based on transformations of country-specific statistics, which allow for parameter heterogeneity across countries. Using GLS techniques, we modify the two tests to eliminate the upward size distortion induced by cross-sectional dependence among contemporaneous real exchange rate innovations. Second, we consider two tests based on a fixed-effects specification: these tests allow for cross-sectional dependence but impose parameter homogeneity. Three of the four tests provide emphatic support for real exchange rate stationary during the post-Bretton Woods era among relatively open economies. Monte Carlo experiments indicate that the three tests have considerable power against the unit root null. One test allowing parameter heterogeneity provides mixed support for stationarity, but has only limited power against the null.

Keywords: Purchasing power parity; Foreign exchange (search for similar items in EconPapers)
Date: 2000
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Working Paper: Purchasing power parity: three stakes through the heart of the unit root null (1999) Downloads
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