Panel Stationarity Tests for Purchasing Power Parity with Cross-Sectional Dependence

Abstract:     
We investigate the purchasing power parity hypothesis for a group of 17 countries using a new panel based test of stationarity that allows for arbitrary cross-sectional dependence. We treat the short run time series dynamics non-parametrically and thus avoid the need to fit separate, and potentially misspecified, models for the individual series. The statistic is simple to compute and uses standard Normal critical values, even in the presence of a wide range of deterministic components. We also show how the test can be applied using an approximate factor model for cross sectional dependence. Taken together, these features provide a generally applicable solution to the problem of testing for stationarity versus unit roots in macro-panel based data. The tests find significant evidence against the purchasing power parity hypothesis being true.

JEL Classification: C12, C32, C33

Accepted Paper Series