Parity Reversion in Real Exchange Rates: Fast, Slow, or Not at All?

43 Pages Posted: 15 Feb 2006

See all articles by Paul Anthony Cashin

Paul Anthony Cashin

International Monetary Fund (IMF)

C. John McDermott

National Bank of New Zealand

Date Written: July 2004

Abstract

Consensus estimates put the half-life of deviations from purchasing power parity (PPP) at about four years (Rogoff, 1996). However, conventional least squares estimates of half-lives are biased downward. Accordingly, as a preferred measure of the persistence of real exchange rate shocks, this study uses median-unbiased estimators of the half-life of deviations from parity, which correct for the downward bias of conventional estimators. The paper tests for PPP using real effective exchange rate data for 90 developed and developing countries in the post-Bretton Woods period. Support for PPP is found, as the majority of countries experience finite deviations of real exchange rates from parity. The speed of parity reversion is found to be typically much faster for developed countries than for developing countries, and to be considerably faster for countries with flexible nominal exchange rate regimes in comparison with countries having fixed nominal exchange rate regimes.

Keywords: Parity reversion, real exchange rate, post-Bretton Woods

JEL Classification: C22, F31, F41

Suggested Citation

Cashin, Paul Anthony and McDermott, C. John, Parity Reversion in Real Exchange Rates: Fast, Slow, or Not at All? (July 2004). IMF Working Paper No. 04/128, Available at SSRN: https://ssrn.com/abstract=878953

Paul Anthony Cashin (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

C. John McDermott

National Bank of New Zealand ( email )

P.O. Box 540
Wellington
New Zealand

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