Spatial Considerations on the PPP Debate

21 Pages Posted: 8 May 2013

See all articles by Michele Ca' Zorzi

Michele Ca' Zorzi

European Central Bank (ECB)

Alexander Chudik

Federal Reserve Banks - Federal Reserve Bank of Dallas

Date Written: April 8, 2013

Abstract

This paper studies the influence of aggregating across space when (i) testing the PPP theory or more generally pair-wise cointegration and (ii) evaluating the PPP puzzle. Our contribution is threefold: we show that aggregating foreign data and applying an ADF test may lead to erroneously reject the PPP hypothesis. We then show, on the basis of theoretical arguments as well as Monte Carlo experiments, that a sizable bias in the estimates of half-life deviations to PPP may be due to the effect of aggregation across space. We finally illustrate empirically the importance of spatial considerations when estimating the speed of price convergence among euro area countries.

Keywords: Half-life estimates, PPP, price convergence, cointegration, aggregation across space

JEL Classification: C23, F41

Suggested Citation

Ca' Zorzi, Michele and Chudik, Alexander, Spatial Considerations on the PPP Debate (April 8, 2013). ECB Working Paper No. 1534. Available at SSRN: https://ssrn.com/abstract=2246578

Michele Ca' Zorzi (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Alexander Chudik

Federal Reserve Banks - Federal Reserve Bank of Dallas ( email )

2200 North Pearl Street
PO Box 655906
Dallas, TX 75265-5906
United States

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