Abstract: We provide a comprehensive analysis of the purchasing power parity
hypothesis, relying on a linear panel data framework. First, we
consider two panel unit root tests, based on transformations of
country-specific statistics, which allow for parameter heterogeneity
across countries. Using GLS techniques, we modify the two tests to
eliminate the upward size distortion induced by cross-sectional
dependence among contemporaneous real exchange rate innovations.
Second, we consider two tests based on a fixed-effects specification:
these tests allow for cross-sectional dependence but impose parameter
homogeneity. Three of the four tests provide emphatic support for real
exchange rate stationary during the post-Bretton Woods era among
relatively open economies. Monte Carlo experiments indicate that the
three tests have considerable power against the unit root null. One
test allowing parameter heterogeneity provides mixed support for
stationarity, but has only limited power against the
null.
Keywords: Purchasing power parity, panel data unit root tests
Full paper (3312 KB PDF)
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Last update: May 17, 2000
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