IDEAS home Printed from https://ideas.repec.org/p/ihs/ihsesp/159.html
   My bibliography  Save this paper

Panel Data Tests of PPP. A Critical Overview

Author

Listed:
  • Caporale, Guglielmo Maria

    (London South Bank University)

  • Cerrato, Mario

    (London Metropolitan University)

Abstract

This paper reviews panel unit root and cointegration tests in the context of PPP. It highlights various drawbacks of existing methods. First, unit root tests suffer from severe size distortions in the presence of negative moving average errors. Second, the common demeaning procedure to correct for the bias resulting from homogeneous cross-sectional dependence is not effective; more worryingly, it introduces cross-correlation when it is not already present. Third, standard corrections for the case of heterogeneous cross-sectional dependence do not generally produce consistent estimators. Fourth, if there is between-group correlation in the innovations, the SURE estimator is affected by similar problems to FGLS methods, and does not necessarily outperform OLS. Finally, cointegration between different groups in the panel could also be a source of size distortions. We offer some empirical guidelines to deal with these problems, but conclude that panel methods are unlikely to solve the PPP puzzle.

Suggested Citation

  • Caporale, Guglielmo Maria & Cerrato, Mario, 2004. "Panel Data Tests of PPP. A Critical Overview," Economics Series 159, Institute for Advanced Studies.
    • Handle: RePEc:ihs:ihsesp:159
    as

    Download full text from publisher

    File URL: https://irihs.ihs.ac.at/id/eprint/1579
    File Function: First version, 2004
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. John Y. Campbell & Pierre Perron, 1991. "Pitfalls and Opportunities: What Macroeconomists Should Know about Unit Roots," NBER Chapters, in: NBER Macroeconomics Annual 1991, Volume 6, pages 141-220, National Bureau of Economic Research, Inc.
    2. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
    3. Jushan Bai & Serena Ng, 2002. "Determining the Number of Factors in Approximate Factor Models," Econometrica, Econometric Society, vol. 70(1), pages 191-221, January.
    4. Wu, Yangru, 1996. "Are Real Exchange Rates Nonstationary? Evidence from a Panel-Data Test," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(1), pages 54-63, February.
    5. Caner, M. & Kilian, L., 2001. "Size distortions of tests of the null hypothesis of stationarity: evidence and implications for the PPP debate," Journal of International Money and Finance, Elsevier, vol. 20(5), pages 639-657, October.
    6. Lyhagen, Johan, 2000. "Why not use standard panel unit root test for testing PPP," SSE/EFI Working Paper Series in Economics and Finance 413, Stockholm School of Economics.
    7. Papell, David H., 1997. "Searching for stationarity: Purchasing power parity under the current float," Journal of International Economics, Elsevier, vol. 43(3-4), pages 313-332, November.
    8. M. Hashem Pesaran, 2007. "A simple panel unit root test in the presence of cross-section dependence," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 22(2), pages 265-312.
    9. Lothian, James R., 1997. "Multi-country evidence on the behavior of purchasing power parity under the current float," Journal of International Money and Finance, Elsevier, vol. 16(1), pages 19-35, February.
    10. Canzoneri, Matthew B. & Cumby, Robert E. & Diba, Behzad, 1999. "Relative labor productivity and the real exchange rate in the long run: evidence for a panel of OECD countries," Journal of International Economics, Elsevier, vol. 47(2), pages 245-266, April.
    11. Froot, Kenneth A. & Rogoff, Kenneth, 1995. "Perspectives on PPP and long-run real exchange rates," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 32, pages 1647-1688, Elsevier.
    12. Lopez, Claude & Murray, Christian J & Papell, David H, 2005. "State of the Art Unit Root Tests and Purchasing Power Parity," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(2), pages 361-369, April.
    13. Im, Kyung So & Pesaran, M. Hashem & Shin, Yongcheol, 2003. "Testing for unit roots in heterogeneous panels," Journal of Econometrics, Elsevier, vol. 115(1), pages 53-74, July.
    14. Karlsson, Sune & Lothgren, Mickael, 2000. "On the power and interpretation of panel unit root tests," Economics Letters, Elsevier, vol. 66(3), pages 249-255, March.
    15. Koedijk, Kees G. & Schotman, Peter, 1990. "How to beat the random walk : An empirical model of real exchange rates," Journal of International Economics, Elsevier, vol. 29(3-4), pages 311-332, November.
    16. Caner, Mehmet & Kilian, Lutz, 1999. "Size distortions of tests of the null hypothesis of stationarity: Evidence and implications for applied work," ZEI Working Papers B 12-1999, University of Bonn, ZEI - Center for European Integration Studies.
    17. G. M. Grossman & K. Rogoff (ed.), 1995. "Handbook of International Economics," Handbook of International Economics, Elsevier, edition 1, volume 3, number 3.
    18. Coakley, Jerry & Fuertes, Ana Maria, 1997. "New panel unit root tests of PPP," Economics Letters, Elsevier, vol. 57(1), pages 17-22, November.
    19. Peter Phillips & Hyungsik Moon, 2000. "Nonstationary panel data analysis: an overview of some recent developments," Econometric Reviews, Taylor & Francis Journals, vol. 19(3), pages 263-286.
    20. Murray, Christian J. & Papell, David H., 2002. "The purchasing power parity persistence paradigm," Journal of International Economics, Elsevier, vol. 56(1), pages 1-19, January.
    21. Paul Hallwood & Ronald MacDonald, 2008. "International Money and Finance," Working papers 2008-02, University of Connecticut, Department of Economics.
    22. Anindya Banerjee & Massimiliano Marcellino & Chiara Osbat, 2005. "Testing for PPP: Should we use panel methods?," Empirical Economics, Springer, vol. 30(1), pages 77-91, January.
    23. Suzanne McCoskey & Chihwa Kao, 1998. "A residual-based test of the null of cointegration in panel data," Econometric Reviews, Taylor & Francis Journals, vol. 17(1), pages 57-84.
    24. Engle, Robert & Granger, Clive, 2015. "Co-integration and error correction: Representation, estimation, and testing," Applied Econometrics, Russian Presidential Academy of National Economy and Public Administration (RANEPA), vol. 39(3), pages 106-135.
    25. Larsson, Rolf & Lyhagen, Johan, 1999. "Likelihood-Based Inference in Multivariate Panel Cointegration Models," SSE/EFI Working Paper Series in Economics and Finance 331, Stockholm School of Economics.
    26. Serena Ng & Pierre Perron, 2001. "LAG Length Selection and the Construction of Unit Root Tests with Good Size and Power," Econometrica, Econometric Society, vol. 69(6), pages 1519-1554, November.
    27. Peter C. B. Phillips & Hyungsik R. Moon, 1999. "Linear Regression Limit Theory for Nonstationary Panel Data," Econometrica, Econometric Society, vol. 67(5), pages 1057-1112, September.
    28. Sargan, J D & Bhargava, Alok, 1983. "Maximum Likelihood Estimation of Regression Models with First Order Moving Average Errors When the Root Lies on the Unit Circle," Econometrica, Econometric Society, vol. 51(3), pages 799-820, May.
    29. Mark, Nelson C., 1990. "Real and nominal exchange rates in the long run: An empirical investigation," Journal of International Economics, Elsevier, vol. 28(1-2), pages 115-136, February.
    30. Lothian, James R & Taylor, Mark P, 1996. "Real Exchange Rate Behavior: The Recent Float from the Perspective of the Past Two Centuries," Journal of Political Economy, University of Chicago Press, vol. 104(3), pages 488-509, June.
    31. Coakley, Jerry & Fuertes, Ana-Marie, 2000. "Is There a Base Currency Effect in Long-Run PPP?," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 5(4), pages 253-263, October.
    32. Peter C. B. Phillips & Donggyu Sul, 2003. "Dynamic panel estimation and homogeneity testing under cross section dependence *," Econometrics Journal, Royal Economic Society, vol. 6(1), pages 217-259, June.
    33. Larsson, Rolf & Lyhagen, Johan, 2000. "Testing for common cointegrating rank in dynamic panels," SSE/EFI Working Paper Series in Economics and Finance 378, Stockholm School of Economics.
    34. MacDonald, Ronald, 1996. "Panel unit root tests and real exchange rates," Economics Letters, Elsevier, vol. 50(1), pages 7-11, January.
    35. Leybourne, S J & McCabe, B P M, 1994. "A Consistent Test for a Unit Root," Journal of Business & Economic Statistics, American Statistical Association, vol. 12(2), pages 157-166, April.
    36. Matthew Higgins & Egon Zakrajšek, 1999. "Purchasing power parity: three stakes through the heart of the unit root null," Staff Reports 80, Federal Reserve Bank of New York.
    37. O'Connell, Paul G. J., 1998. "The overvaluation of purchasing power parity," Journal of International Economics, Elsevier, vol. 44(1), pages 1-19, February.
    38. Oh, Keun-Yeob, 1996. "Purchasing power parity and unit root tests using panel data," Journal of International Money and Finance, Elsevier, vol. 15(3), pages 405-418, June.
    39. Enders, Walter & Falk, Barry, 1998. "Threshold-autoregressive, median-unbiased, and cointegration tests of purchasing power parity," International Journal of Forecasting, Elsevier, vol. 14(2), pages 171-186, June.
    40. Jerry Coakley & Ana-Maria Fuertes & Ron Smith, 2002. "A Principal Components Approach to Cross-Section Dependence in Panels," 10th International Conference on Panel Data, Berlin, July 5-6, 2002 B5-3, International Conferences on Panel Data.
    41. Lothian, James R. & Taylor, Mark P., 1997. "Real exchange rate behavior," Journal of International Money and Finance, Elsevier, vol. 16(6), pages 945-954, December.
    42. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254.
    43. repec:bla:obuest:v:61:y:1999:i:0:p:607-29 is not listed on IDEAS
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Guglielmo Maria Caporale & Christoph Hanck, 2010. "Are PPP tests erratically behaved? Some panel evidence," International Review of Applied Economics, Taylor & Francis Journals, vol. 24(2), pages 203-221.
    2. Guglielmo Maria Caporale & Christoph Hanck, 2009. "Cointegration tests of PPP: do they also exhibit erratic behaviour?," Applied Economics Letters, Taylor & Francis Journals, vol. 16(1), pages 9-15.
    3. Edward Bernard Bastiaan de Rivera y Rivera & Diógenes Manoel Leiva Martin & Emerson Fernandes Marçal & Leonardo Fernando Cruz Basso, 2012. "Present value model between prices and dividends with constant and time-varying expected returns: enterprise-level Brazilian stock market evidence from non-stationary panels," Brazilian Business Review, Fucape Business School, vol. 9(4), pages 51-86, October.
    4. Martin Wagner, 2008. "On PPP, unit roots and panels," Empirical Economics, Springer, vol. 35(2), pages 229-249, September.
    5. Dierk Herzer & Julian Donaubauer, 2018. "The long-run effect of foreign direct investment on total factor productivity in developing countries: a panel cointegration analysis," Empirical Economics, Springer, vol. 54(2), pages 309-342, March.
    6. Miles, William, 2020. "House price convergence in the euro zone: A pairwise approach," Economic Systems, Elsevier, vol. 44(3).
    7. Woo, Kai-Yin & Lee, Shu-Kam, 2009. "Detecting intra-national PPP model in China: A median-unbiased estimation approach," Economic Modelling, Elsevier, vol. 26(5), pages 1029-1032, September.
    8. Dierk Herzer & Holger Strulik, 2017. "Religiosity and income: a panel cointegration and causality analysis," Applied Economics, Taylor & Francis Journals, vol. 49(30), pages 2922-2938, June.
    9. Norkutė, Milda & Westerlund, Joakim, 2021. "The factor analytical approach in near unit root interactive effects panels," Journal of Econometrics, Elsevier, vol. 221(2), pages 569-590.
    10. Dierk Herzer, 2017. "The Long-run Relationship Between Trade and Population Health: Evidence from Five Decades," The World Economy, Wiley Blackwell, vol. 40(2), pages 462-487, February.
    11. Ryan Greenaway‐McGrevy & Nelson C. Mark & Donggyu Sul & Jyh‐Lin Wu, 2018. "Identifying Exchange Rate Common Factors," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 59(4), pages 2193-2218, November.
    12. Cerrato, Mario & Sarantis, Nicholas, 2007. "A bootstrap panel unit root test under cross-sectional dependence, with an application to PPP," Computational Statistics & Data Analysis, Elsevier, vol. 51(8), pages 4028-4037, May.
    13. Julian Ramajo & Montserrat Ferre, 2010. "Purchasing power parity revisited: evidence from old and new tests for an organisation for economic co-operation and development panel," Applied Economics, Taylor & Francis Journals, vol. 42(17), pages 2243-2260.
    14. Herzer, Dierk, 2014. "Unions and income inequality: a heterogenous cointegration and causality analysis," Working Paper 146/2014, Helmut Schmidt University, Hamburg.
    15. Luis Alberiko Gil-Alaña & Guiglielmo Maria Caporale, 2012. "Testing the PPP Hypothesis in the Sub-Saharan Countries," NCID Working Papers 10/2012, Navarra Center for International Development, University of Navarra.
    16. Guglielmo Maria Caporale & Andros Gregoriou, 2009. "Non-normality, heteroscedasticity and recursive unit root tests of PPP: solving the PPP puzzle?," Applied Economics Letters, Taylor & Francis Journals, vol. 16(3), pages 223-226.
    17. Julián Ramajo Hernández(1) & Montserrat Ferré Carracedo(2), "undated". "Testing For Long-Run Purchasing Power Parity In The Post Bretton Woods Era: Evidence From Old And New Tests," Working Papers 24-05 Classification-JEL , Instituto de Estudios Fiscales.
    18. Luke Lin & Chun I. Lee, 2016. "Central Bank Intervention, Exchange Rate Regime and the Purchasing Power Parity," The World Economy, Wiley Blackwell, vol. 39(8), pages 1256-1274, August.
    19. Paweł Baranowski, 2005. "Wpływ inflacji na inwestycje w kapitał rzeczowy w krajach Unii Europejskiej," Gospodarka Narodowa. The Polish Journal of Economics, Warsaw School of Economics, issue 11-12, pages 19-30.
    20. Bahram Adrangi & Mary E. Allender & Kambiz Raffiee, 2011. "Exchange Rates and Inflation Rates: Exploring Nonlinear Relationships," Review of Economics & Finance, Better Advances Press, Canada, vol. 1, pages 1-16, April.
    21. Luzzati, Tommaso & Orsini, Marco & Gucciardi, Gianluca, 2018. "A multiscale reassessment of the Environmental Kuznets Curve for energy and CO2 emissions," Energy Policy, Elsevier, vol. 122(C), pages 612-621.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Maican, Florin G. & Sweeney, Richard J., 2013. "Real exchange rate adjustment in European transition countries," Journal of Banking & Finance, Elsevier, vol. 37(3), pages 907-926.
    2. Martin Wagner, 2008. "On PPP, unit roots and panels," Empirical Economics, Springer, vol. 35(2), pages 229-249, September.
    3. Ahmad Zubaidi Baharumshah & Raj Aggarwal & Chan Tze Haw, 2007. "East Asian Real Exchange Rates and PPP: New Evidence from Panel-data Tests," Global Economic Review, Taylor & Francis Journals, vol. 36(2), pages 103-119.
    4. Syed A. Basher & Josep Lluís Carrion-i-Silvestre, 2007. "Another Look at the Null of Stationary RealExchange Rates. Panel Data with Structural Breaks and Cross-section Dependence," IREA Working Papers 200710, University of Barcelona, Research Institute of Applied Economics, revised May 2007.
    5. Imed Drine & Christophe Rault, 2008. "Purchasing Power Parity For Developing And Developed Countries. What Can We Learn From Non‐Stationary Panel Data Models?," Journal of Economic Surveys, Wiley Blackwell, vol. 22(4), pages 752-773, September.
    6. Miguel Carvalho & Paulo Júlio, 2012. "Digging out the PPP hypothesis: an integrated empirical coverage," Empirical Economics, Springer, vol. 42(3), pages 713-744, June.
    7. Choi, Chi-Young, 2004. "Searching for evidence of long-run PPP from a post-Bretton Woods panel: separating the wheat from the chaff," Journal of International Money and Finance, Elsevier, vol. 23(7-8), pages 1159-1186.
    8. Dimitrios Malliaropulos & Ekaterini Panopoulou & Nikitas Pittis & Theologos Pantelidis, 2006. "The Contribution of Growth and Interest Rate Differentials to the Persistence of Real Exchange Rates," The Institute for International Integration Studies Discussion Paper Series iiisdp135, IIIS.
    9. Chortareas, Georgios & Kapetanios, George, 2009. "Getting PPP right: Identifying mean-reverting real exchange rates in panels," Journal of Banking & Finance, Elsevier, vol. 33(2), pages 390-404, February.
    10. Papell, David H., 2002. "The great appreciation, the great depreciation, and the purchasing power parity hypothesis," Journal of International Economics, Elsevier, vol. 57(1), pages 51-82, June.
    11. Taylor, Mark P. & Sarno, Lucio, 1998. "The behavior of real exchange rates during the post-Bretton Woods period," Journal of International Economics, Elsevier, vol. 46(2), pages 281-312, December.
    12. Christian Dreger & Eric Girardin, 2007. "Does the Nominal Exchange Rate Regime Affect the Long Run Properties of Real Exchange Rates?," Discussion Papers of DIW Berlin 746, DIW Berlin, German Institute for Economic Research.
    13. Chortareas, Georgios & Kapetanios, George, 2009. "Getting PPP right: Identifying mean-reverting real exchange rates in panels," Journal of Banking & Finance, Elsevier, vol. 33(2), pages 390-404, February.
    14. Cerrato, Mario & Sarantis, Nicholas, 2008. "Symmetry, proportionality and the purchasing power parity: Evidence from panel cointegration tests," International Review of Economics & Finance, Elsevier, vol. 17(1), pages 56-65.
    15. Mkenda, Beatrice Kalinda, 2001. "An Empirical Test of Purchasing Power Parity in Selected African Countries - a Panel Data Approach," Working Papers in Economics 39, University of Gothenburg, Department of Economics.
    16. Carlsson, Mikael & Lyhagen, Johan & Österholm, Pär, 2007. "Testing for Purchasing Power Parity in Cointegrated Panels," Working Paper Series 2008:1, Uppsala University, Department of Economics.
    17. Hwa-Taek Lee & Gawon Yoon, 2013. "Does purchasing power parity hold sometimes? Regime switching in real exchange rates," Applied Economics, Taylor & Francis Journals, vol. 45(16), pages 2279-2294, June.
    18. Papell, David H. & Theodoridis, Hristos, 1998. "Increasing evidence of purchasing power parity over the current float," Journal of International Money and Finance, Elsevier, vol. 17(1), pages 41-50, February.
    19. Ozgur Aslan & Levent Korap, 2009. "Are real exchange rates mean reverting? Evidence from a panel of OECD countries," Applied Economics Letters, Taylor & Francis Journals, vol. 16(1), pages 23-27.
    20. Jean Imbs & Haroon Mumtaz & Morten O. Ravn & Hélène Rey, 2005. "PPP Strikes Back: Aggregation And the Real Exchange Rate," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 120(1), pages 1-43.

    More about this item

    Keywords

    Purchasing Power Parity (PPP); Panel unit root and cointegration tests; Cross-sectional dependence;
    All these keywords.

    JEL classification:

    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • F31 - International Economics - - International Finance - - - Foreign Exchange

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ihs:ihsesp:159. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Doris Szoncsitz (email available below). General contact details of provider: https://edirc.repec.org/data/deihsat.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.