PPP: Delusion or Reality? Evidence from a Nonlinear Analysis

Open Economies Review, Forthcoming

32 Pages Posted: 12 Mar 2009

See all articles by Juan-Angel Jiménez-Martin

Juan-Angel Jiménez-Martin

Complutense University of Madrid

M-Dolores Robles

Universidad Complutense de Madrid (UCM) - Faculty of Economics and Business Administration; ICAE

Date Written: March 10, 2009


In this paper we analyze the validity of the purchasing power parity (PPP) in a nonlinear framework using data for 18 bilateral US dollar exchange rates. Following Enders and Ludlow (2002), we use unit root and cointegration tests that do not assume a specific nonlinear adjustment. We find evidence of non-linear mean reversion in deviations from the PPP equilibrium in 11 out of 18 currencies. Additionally, to disentangle the respective contribution of exchange rate and prices to the adjustment toward the long run equilibrium, we estimate a Vector Error Correction Model. According to our empirical analysis, there exists a nonlinear mechanism to correct for deviation from the PPP equilibrium that comes mainly from the exchange rates. This is consistent with theoretical arguments on international goods markets under transaction costs as well as with an emerging strand of empirical literature. These results highlight the importance of neglecting the possibility of nonlinearity in the debate about the PPP and provide empirical evidence that supports the scenario of the PPP hypothesis as a reality.

Keywords: Unit-root test, Cointegration test, Fourier approximation, nonlinear VECM, exchange rates, purchasing power parity

JEL Classification: F31, C22, C32

Suggested Citation

Jiménez-Martin, Juan-Angel and Robles Fernandez, María-Dolores, PPP: Delusion or Reality? Evidence from a Nonlinear Analysis (March 10, 2009). Open Economies Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1356809

Juan-Angel Jiménez-Martin (Contact Author)

Complutense University of Madrid ( email )

Complutense University of Madrid
Campus de somosaguas
Pozuelo de Alarcon, Madrid 28223
+34 91 3942355 (Phone)

HOME PAGE: http://www.ucm.es/fundamentos-analisis-economico2/jajm

María-Dolores Robles Fernandez

Universidad Complutense de Madrid (UCM) - Faculty of Economics and Business Administration ( email )

School of Business Administration
Somosaguas Campus
Madrid, Madrid 28223
+91 394 2347 (Phone)
+91 394 2613 (Fax)

HOME PAGE: http://https://www.ucm.es/fundamentos-analisis-economico2/MDRF

ICAE ( email )

Campus de Somosaguas
Madrid, 28223

HOME PAGE: http://https://www.ucm.es/fundamentos-analisis-economico2/MDRF

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