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An Unbiased Appraisal of Purchasing Power Parity

Christopher McDermott () and Paul Cashin ()

No 01/196, IMF Working Papers from International Monetary Fund

Abstract: Univariate studies of the hypothesis of unit roots in real exchange rates have yielded consensus point estimates of the half-life of deviations from purchasing power parity of between three to five years. However, least squares-based estimates of half-lives are biased downward. Accordingly, we follow Andrews (1993) and use median-unbiased estimators of the half-life of deviations from parity as a preferred measure of the persistence of real exchange rate shocks. We study this issue using real effective exchange rate (REER) data for 22 industrial countries in the post-Bretton Woods period. Three methods of bias correction are implemented, which yield cross-country averages of half-lives of deviations from parity ranging between 4 to 15 years, with the REER of several countries displaying permanent deviations from parity.

Keywords: Foreign exchange; Purchasing power parity; Median-unbiased estimation, shock persistence, exchange rate, exchange rates, confidence intervals, confidence interval, real exchange rates, (search for similar items in EconPapers)
Date: 2001-12-01
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