Istituto di Economia Internazionale - Linear and Nonlinear Attractors in Purchasing Power Parity

Recent Articles

Read more about our latest published articles.

Review’s Archive

Corresponding Author:
Imad Moosa, School of Economics, Finance and Marketing, RMIT University, Melbourne, Australia

Coauthors:
Ming MA, Beijing Institute of Technology, Beijing, China

Linear and Nonlinear Attractors in Purchasing Power Parity

Volume 71 - Issue 2, May 2018
(pp. 149-172)
JEL classification: C20, F31, F41
Keywords: Purchasing Power Parity, Nonlinearity, Error Correction, Non-Nested Model Selection Tests

Abstract

In an examination of the PPP hypothesis over the period 1973-2014 strong evidence is found for nonlinearity, not only in the adjustment process towards equilibrium but also in the long-run relation itself. Because of the use of a data sample with a long span we also found evidence for PPP, even if it is represented by a model with linear adjustment to a linear attractor, although adjustment towards long-run equilibrium is faster when a nonlinear attractor is used. Perhaps a controversial finding is that it may be always possible to find a nonlinear attractor in the form of a high order polynomial that produces stationary residuals, implying the validity of PPP.

Read the full article

Download the article in PDF format to read and print.

Bibliography

Baum, C.F., J.T. Barkoulas and M. Caglayan (2001), “Nonlinear Adjustment to Purchasing Power Parity in the Post-Bretton Woods Era”, Journal of International Money and Finance, 20(3), 379-399.
Beckmann, J. (2013), “Nonlinear Adjustment, Purchasing Power Parity and the Role of Nominal Exchange Rates and Prices”, North American Journal of Economics and Finance, 24(C), 176-190.
Benamar, A., K. Ait Ziane, H. Amimi and M. Benbouziane (2009), “A FI-STAR Approach to the Purchasing Power Parity in the North African Countries”, International Business Research, 2(3), 136-147.
Breitung, J. (2001), “Rank Tests for Nonlinear Cointegration”, Journal of Business and Economic Statistics, 19(3), 331-340.
Camarero, M., J. Ordóñez and P. Vilar (2008), “Nonlinear Adjustment in the Real Euro-Dollar Exchange Rate: The Role of the Productivity Differential as a Fundamental”, Working Paper, Department of Economics, Jaume I University.
Cheung, Y-W. and K.S. Lai (1993), “A Fractional Cointegration Analysis of Purchasing Power Parity”, Journal of Business and Economic Statistics, 11(1), 103-112.
Coleman, A.M. (1995), “Arbitrage, Storage and the Law of One Price: New Theory for the Time Series Analysis of an Old Problem”, Working Paper, Princeton University.
Cuestas, J.C. and P.J. Regis (2013), “Purchasing Power Parity in OECD Countries: Nonlinear Unit Root Tests Revisited”, Economic Modelling, 32(May), 343-346.
Dieu-Hang, T. and T. Kompas (2010), “Purchasing Power Parity: Evidence from a New Testing Procedure in the Nonlinear Modified ESTAR Framework”, Crawford School of Economics and Government, Australian National University, available at SSRN: <https://ssrn.com/abstract=1687434> or <http://dx.doi.org/10.2139/ssrn.1687434>.
Dumas, B. (1992), “Dynamic Equilibrium and the Real Exchange Rate in a Spatially Separated World”, Review of Financial Studies, 5(2), 153-180.
Escribano, A. (1987), “Error Correction Systems: Non-linear Adjustmenst to Long-run Relationships”, CORE Discussion Paper No. 8730.
Froot, K.A. and K.S. Rogoff (1995), Perspectives on PPP and Long-run Real Exchange Rates, in M. Grossman, K.S. Rogoff (Eds), “Handbook of International Economics”, North Holland: Amsterdam.
Granger, C.W.J. (1991), Some Recent Generalisations of Cointegration and the Analysis of Long-run Relationships, in R.F. Engle, C.W.J. Granger (Eds), “Long-run Economic Relationships: Readings in Cointegration”, Oxford University Press: Oxford
Harvey, D.I., S.J. Leybourne and B. Xiao (2008), “A Powerful Test for Linearity when the Order of Integration is Unknown”, Studies in Nonlinear Dynamics and Econometrics, 12(3), 1-24.
Haug, A.A. and S. Basher (2011), “Linear or Nonlinear Cointegration in the Purchasing Power Parity Relationship?”, Applied Economics, 43(2), 185-196.
Hendry, D.F. and N. Ericsson (1991), “An Econometric Analysis of UK Money Demand in ‘Monetary Trends in the United States and the United Kingdom’ by Milton Friedman and Anna J. Schwartz”, American Economic Review, 81(1), 8-38.
Hong, S.H. and P.C.B. Phillips (2010), “Testing Linearity in Cointegrating Relations with an Application to Purchasing Power Parity”, Journal of Business and Economic Statistics, 28(1), 96-114.
Juselius, K. and R. MacDonald (2004), “International Parity Relationships between the USA and Japan”, Japan and the World Economy, 16(1), 17-34.
Kilian, L. and M.P. Taylor (2003), “Why is it so Difficult to Beat the Random Walk Forecast of Exchange Rates”, Journal of International Economics, 60(1), 85-107.
Kruse, R. (2011), “A New Unit Root Test Against ESTAR Based on a Class of Modified Statistics”, Statistical Papers, 52(1), 71-85.
Lahiri, K. and N. Mamingi (1995), “Testing for Cointegration: Power versus Frequency of Observation--Another View”, Economics Letters, 49(2), 121-124.
Martín, J., J. Ángel and R.F.M. Dolores (2005), “Non-Linear Adjustment to Purchasing Power Parity: An Analysis Using Fourier Approximations”, Documentos de Trabajo del Instituto Complutense de Análisis Económico (ICAE), No 0508.
Michael, P., A.R. Nobay and D.A. Peel (1997), “Transactions Costs and Nonlinear Adjustment in Real Exchange Rates: An Empirical Investigation”, Journal of Political Economy, 105(4), 862-879.
Mizon, G.E. and J-F. Richard (1986), “The Encompassing Principle and its Application to Testing Non-Nested Hypotheses”, Econometrica, 54(3), 657-678.
Moosa, I.A. (1994), “Testing Nonlinearities in Purchasing Power Parity”, Applied Economics Letters, 1(3), 41-43.
Moosa, I.A. (2000), “Misinterpreting Gustav Cassel: Origins and Implications for the Contemporary Literature”, History of Economics Review, 30(1), 41-55.
Moosa, I.A. and R.H. Bhatti (1999), “Some Popular Misconceptions about the Theory and Empirical Testing of Purchasing Power Parity”, Journal of International Economic Studies, 13(1999), 147-161.
Obstfeld, M. and A. Taylor (1997), “Nonlinear Aspects of Goods-Market Arbitrage and Adjustment: Heckscher’s Commodity Points Revisited”, Journal of the Japanese and International Economies, 11(4), 441-479.
O’Connell, P.G. (1998), “Market Frictions and Real Exchange Rates”, Journal of International Money and Finance, 17(1), 71-95.
O’Connell, P.G. and S. Wei (1997), “The Bigger they are, the Harder they Fall: How Price Differences Across U.S. Cities are Arbitraged”, National Bureau of Economic Research Working Papers, No 6089.
Pedroni, P. (2001), “Purchasing Power Parity Tests in Cointegrated Panels”, Review of Economics and Statistics, 83(4), 727-731.
Pesaran, M.H. (1974), “On the General Problem of Model Selection”, Review of Economic Studies, 41(2), 153-171.
Pesaran, B. and M.H. Pesaran (2009), Time Series Econometrics: Using Microfit 5.0, Oxford University Press: Oxford.
Sarno, L., M.P. Taylor and I. Chowdhury (2004), “Nonlinear Dynamics in Deviations from the Law of One Price: A Broad-Based Empirical Study”, Journal of International Money and Finance, 23(1), 1-25.
Sercu, P., R. Uppal and C. Van Hulle (1995), “The Exchange Rate in the Presence of Transaction Costs: Implications for Tests of Purchasing Power Parity”, Journal of Finance, 50(4), 1309-1319.
Shiller, R.J. and P. Perron (1985), “Testing the Random Walk Hypothesis: Power versus Frequency of Observation”, Economics Letters, 18(4), 381-386.
Taylor, M.P., D.A. Peel and L. Sarno (2001), “Nonlinear Mean-Reversion in Real Exchange Rates: Toward a Solution to the Purchasing Power Parity Puzzles”, International Economic Review, 42(4), 1015-1042.
Uppal, R. (1993), “A General Equilibrium Model of International Portfolio Choice”, Journal of Finance, 48(2), 529-553.
van Dijk, D., P.H. Franses and R. Paap (2002), “A Nonlinear Long Memory Model, with an Application to US Unemployment”, Journal of Econometrics, 110(2), 135-165.

Recent Articles

Review’s Archive

Linear and Nonlinear Attractors in Purchasing Power Parity

Abstract

Read the full article

Bibliography

Register your account

Authors’ login

Institute for International Economics of the Genoa Chamber of Commerce

Institute for International Economics
of the Genoa Chamber of Commerce