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Productivity bias hypothesis claims that deviation of the PPP based exchange rate from the equilibrium rate is mainly due to productivity differentials among countries. Early studies that employed cross‐sectional data in testing the hypothesis provided mixed results. A few time‐series studies have provided some support for the hypothesis. This paper relies on panel data and recent advances in panel unit‐root and panel cointegration analysis and provides strong results supporting the hypothesis. The results are not sensitive to classification of the world by regions.

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