Working Paper Series, Department of Economics, Uppsala University
No 2008:1:
Testing for Purchasing Power Parity in Cointegrated Panels
Mikael Carlsson ()
, Johan Lyhagen ()
and Pär Österholm ()
Abstract: This paper applies the recently developed
maximum-likelihood-panel cointegration method of Larsson and Lyhagen (2007)
to test the strong PPP hypothesis during the recent ‡oat period on data for
the G7 countries. This method is robust in several important dimensions
relative to previous methods, including the well-known issue of
cross-sectional dependence of error terms. The findings using this new
method are contrasted to those from the Pedroni (1995) cointegration tests
and fully modified OLS and dynamic OLS estimators of the cointegrating
vectors. Although the shortcomings of previous methods do matter in various
cases, the overall results are the same across approaches: The strong PPP
hypothesis is forcefully rejected in favor of the weak PPP hypothesis with
heterogeneous cointegrating vectors. As a consequence, the strong PPP
hypothesis does not even seem to be an acceptable approximation of observed
data.
Keywords: Purchasing Power Parity; Panel Cointegration; Maximum Likelihood; Fully Modified OLS; Dynamic OLS; (follow links to similar papers)
JEL-Codes: C33; F31; (follow links to similar papers)
20 pages, December 10, 2007
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