Testing Purchasing Power Parity in the Framework of Vector Error Correction Modelling - Financial and Economic Forecasting (Chapter 14)
18 Pages Posted: 30 Jan 2003
Date Written: October 2002
In this chapter, the necessary condition and the necessary and sufficient condition for purchasing power parity (PPP) are sequentially tested for fourteen bilateral exchange rates. This test is undertaken in the framework of subset vector error correction modelling (VECM) with zero coefficients. This approach is different from the unit root based methods and the results are promising. Of the fourteen exchange rates tested, we find support for the necessary condition for PPP in half of them. The necessary and sufficient condition for PPP is then tested using both a bootstrap procedure and an F test. This condition is consistently accepted for three of the seven exchange rates investigated.
Keywords: Purchasing Power Parity, Vector Error Correction Modelling
JEL Classification: C22, C53, E31
Suggested Citation: Suggested Citation