Long-Run and Short-Run Dynamics of the Exchange Rate in Pakistan: Evidence from Unrestricted Purchasing Power Parity Theory

The Lahore Journal of Economics 13 : 1 (Summer 2008): pp. 29-56

29 Pages Posted: 5 Dec 2017

Date Written: 2008

Abstract

The main focus of this paper is to measure the speed of adjustment of the exchange rate by means of the persistent profile approach developed by Pesaran and Shin (1996) to examine the symmetry and proportionality assumptions of the purchasing power parity (PPP) theory of exchange rates for the Pak-rupee vis-à-vis the US-dollar exchange rate over the period 1982Q2-2005Q4. Using cointegration and vector error-correction modeling approaches, we find considerable support for the validity of weak-form PPP in Pakistan. Furthermore, the symmetry and proportionality assumptions of PPP are not verified. In the short-run, the exchange rate and foreign prices play a significant role in the convergence process to achieve long-run equilibrium. However, the speed of adjustment is very slow and the persistence profiles suggest that almost 4-5 years are required to eliminate deviations and bring the nominal exchange rate in line with the long-run equilibrium path.

Keywords: Exchange Rate, Purchasing Power Parity, Cointegration, Vector Error Correction, Pakistan

JEL Classification: C13, C22, C51, F31, F37

Suggested Citation

Khan, Muhammad Arshad and Qayyum, Abdul, Long-Run and Short-Run Dynamics of the Exchange Rate in Pakistan: Evidence from Unrestricted Purchasing Power Parity Theory (2008). The Lahore Journal of Economics 13 : 1 (Summer 2008): pp. 29-56 . Available at SSRN: https://ssrn.com/abstract=3082888

Muhammad Arshad Khan

Comsats University Islamabad ( email )

Park Road
Chak Shahzad
Islamabad, North-West Frontier Province 44000
Pakistan

No contact information is available for Abdul Qayyum

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