EMPIRICAL INVESTIGATION OF LONG RUN PPP HYPOTHESIS: THE CASE OF TEMPORARY STRUCTURAL BREAK AND ASYMMETRIC ADJUSTMENT

Abstract

This study investigates the validity of the long-run PPP hypothesis for 60 economies using trade-weighted REER indices for the period 1994:01–2020:04. In addition to conventional tests, we also apply a battery of new unit root tests that allow for structural breaks and nonlinear adjustment. Our results suggest that test procedures that allow for both a structural break in the deterministic components of the series and nonlinearities in the adjustment towards equilibrium lead to a more frequent rejection of the unit root null hypothesis. In particular, after allowing for a temporary structural break in the series along with nonlinear adjustment towards a gradually changing equilibrium, we are able to reject the unit root null hypothesis for all countries, thus providing support for the PPP hypothesis.

Data:
Received: 22 Mar 2021
Revised: 12 May 2021
Accepted: 6 Jun 2021
Published: 20 Jun 2021