Does Political Risk Lead to Purchasing Power Disparity? Panel Disaggregated Approach

Abstract

Till date, few studies have attempted to study the impact of political risk on the purchasing power disparity, The studies conducted thus far have been restricted in terms of the political risk components used, countries examined and time span. We add to the existing literature by being the first to examine how thirteen different political risk indices introduced by International Country Risk Guide (henceforth, ICRG) affect the real exchange rate. In this study, we use 86 OECD and NonOECD countries over the time period of 1984-1997, and carry out panel estimation techniques, which include one-way fixed-effects, two-way fixed-effects, one-way random-effects, and two-way random-effects. It is found that regardless of whether countries are classified according to income or region, in most of the cases political risk does have a significant impact on real exchange rate in that risk leads to either real appreciation or depreciation and is instrumental in purchasing power disparity.