Purchasing Power Parity and the Euro Area

39 Pages Posted: 13 Sep 2004

See all articles by Kees C. G. Koedijk

Kees C. G. Koedijk

Tilburg University - Department of Finance

Ben Tims

Erasmus University Rotterdam (EUR) - Rotterdam School of Management (RSM)

Mathijs A. Van Dijk

Erasmus University - Rotterdam School of Management; Erasmus Research Institute of Management (ERIM)

Multiple version iconThere are 3 versions of this paper

Date Written: July 2004

Abstract

This Paper analyzes purchasing power parity (PPP) for the euro area. We study the impact of the introduction of the euro in 1999 on the behavior of real exchange rates. We test the PPP hypothesis for a panel of real exchange rates within the euro area over the period 1973-2003. Our methodology exploits the cross-sectional dependence across real exchange rates and allows for heterogeneity in the rates of mean reversion. We present evidence in favor of PPP for the full panel of real exchange rates, but we show that accounting for cross-country differences within the euro area is essential. The unit root hypothesis can be rejected for some real exchange rates, but evidence for PPP is weak for others. We also investigate PPP between the 'synthetic' euro against several other major currencies over the period 1979-2003. We find support for the PPP hypothesis for the full panel of real exchange rates. When the restriction of a common mean reversion coefficient is relaxed, we reject the unit root hypothesis for the euro-Swiss franc rate only. We conclude that the process of economic integration in Europe has accelerated convergence toward PPP within the euro area.

Keywords: European integration, real exchange rates, purchasing power parity, heterogenous SUR

JEL Classification: F31, F33, G15

Suggested Citation

Koedijk, Kees G. and Tims, Ben and Van Dijk, Mathijs A., Purchasing Power Parity and the Euro Area (July 2004). CEPR Discussion Paper No. 4510. Available at SSRN: https://ssrn.com/abstract=590082

Kees G. Koedijk (Contact Author)

Tilburg University - Department of Finance ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 4663048 (Phone)
+31 13 4662052 (Fax)

Ben Tims

Erasmus University Rotterdam (EUR) - Rotterdam School of Management (RSM) ( email )

P.O. Box 1738
Room T08-21
3000 DR Rotterdam, 3000 DR
Netherlands

Mathijs A. Van Dijk

Erasmus University - Rotterdam School of Management ( email )

P.O. Box 1738
Rotterdam, 3000 DR
Netherlands
+31 10 408 1124 (Phone)
+31 10 408 9017 (Fax)

HOME PAGE: http://mathijsavandijk.com/

Erasmus Research Institute of Management (ERIM)

P.O. Box 1738
3000 DR Rotterdam
Netherlands

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