Cointegration Tests of PPP: Do They Also Exhibit Erratic Behaviour?

21 Pages Posted: 18 Oct 2006

See all articles by Guglielmo Maria Caporale

Guglielmo Maria Caporale

Brunel University London - Department of Economics and Finance; London South Bank University; CESifo (Center for Economic Studies and Ifo Institute); German Institute for Economic Research (DIW Berlin)

Christoph Hanck

University of Dortmund - Department of Statistics

Date Written: September 2006

Abstract

We analyse whether tests of PPP exhibit erratic behaviour (as previously reported by Caporale et al., 2003) even when (possibly unwarranted) homogeneity and proportionality restrictions are not imposed, and trivariate cointegration (stage-three) tests between the nominal exchange rate, domestic and foreign price levels are carried out (instead of stationarity tests on the real exchange rate, as in stage-two tests). We examine the US dollar real exchange rate vis-à-vis 21 other currencies over a period of more than a century, and find that stage-three tests produce similar results to those for stage-two tests, namely the former also behave erratically. This confirms that neither of these traditional approaches to testing for PPP can solve the issue of PPP.

Keywords: Purchasing Power Parity (PPP), real exchange rate, cointegration, stationarity, parameter instability

JEL Classification: C12, C22, F31

Suggested Citation

Caporale, Guglielmo Maria and Hanck, Christoph, Cointegration Tests of PPP: Do They Also Exhibit Erratic Behaviour? (September 2006). Available at SSRN: https://ssrn.com/abstract=938376 or http://dx.doi.org/10.2139/ssrn.938376

Guglielmo Maria Caporale (Contact Author)

Brunel University London - Department of Economics and Finance ( email )

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HOME PAGE: http://www.brunel.ac.uk/about/acad/bbs/bbsstaff/ef_staff/guglielmocaporale/

London South Bank University ( email )

Centre for Monetary and Financial Economics
London
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

German Institute for Economic Research (DIW Berlin) ( email )

Mohrenstra├če 58
Berlin, 10117
Germany

Christoph Hanck

University of Dortmund - Department of Statistics ( email )

D-44221 Dortmund
Germany

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