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An Unbiased Appraisal of Purchasing Power Parity Paul Cashin and C. John McDermott Full Text of this Article (PDF 225K) Abstract:
Univariate studies of the hypothesis of unit roots in real exchange rates have
yielded consensus point estimates of the half-life of deviations from purchasing
power parity (PPP) of between three to five years (Rogoff, 1996). However,
conventional least-squares-based estimates of half-lives are biased downward.
Accordingly, as a preferred measure of the persistence of real exchange rate
shocks we use median-unbiased estimators of the half-life of deviations from
parity, which correct for the downward bias of conventional estimators. We
study this issue using real effective exchange rate (REER) data for 20 industrial
countries in the post–Bretton Woods period. The serial correlation-robust
median-unbiased estimator yields a cross-country average of half-lives of
deviations from parity of about eight years, with the REER of several countries
displaying permanent deviations from parity. However, using the median-unbiased
estimator that is robust to the moving average and heteroskedastic errors
present in real exchange rate data reduces the estimated half-life of parity
deviations. Using this unbiased estimator, we find that the majority of countries
have finite point estimates of half-lives of parity deviation, which is supportive
of PPP holding in the post–Bretton Woods period. We also find that
the average bias-corrected half-life of parity deviations is about five years,
which is consistent with (but at the upper end of) Rogoff’s (1996)
consensus estimate of the half-life of deviations from parity. |
