A Bayesian Analysis of the PPP Puzzle using an Unobserved Components Model

Richard Kleijn () and Herman van Dijk
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Richard Kleijn: Econometric Institute, Erasmus University Rotterdam

No 01-105/4, Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: The failure to describe the time series behaviour of most realexchange rates as temporary deviations from fixedlong-term means may be due to time variation of the equilibriathemselves, see Engel (2000). We implement thisidea using an unobserved components model and decompose theobservations on real exchange rates in long-termcomponents, which capture the time-variation of the mean and inmedium and short-term components whichmeasure temporary deviations. A simulation-based Bayesian analysis isintroduced to compute the posteriordistribution of (functions) of the model parameters. A stationaritytest in this setup indicates that the mean isslowly time-varying. Subsequently, we use our flexible model toderive the implied distributions of some keyfeatures of real exchange rates. Most notably, the half-life ofdeviations from the mean, which is a measure ofpersistence, is lowered. This provides a possible explanation for thePPP puzzle.

Keywords: purchasing power parity puzzle; real exchange rate; time-varying mean; Gibbs sampling (search for similar items in EconPapers)
JEL-codes: C11 C32 C52 F30 (search for similar items in EconPapers)
Date: 2001-11-20
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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Related works:
Working Paper: A Bayesian analysis of the PPP puzzle using an unobserved components model (2001)
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