Are PPP tests erratically behaved? Some panel evidence

Abstract

This paper examines whether, in addition to standard unit root and cointegration tests, panel approaches also produce test statistics behaving erratically when applied to PPP. We show that if appropriate tests (which are robust to cross-sectional dependence and more powerful) are used, any evidence of erratic behaviour disappears, and strong empirical support is found for PPP. It appears therefore that recent advances in panel data econometrics might enable us to settle the PPP debate.

Real exchange rates persistence in the West African monetary zone: a revisit of the PPP puzzle

“…In an attempt to resolve the small sample and slow mean-reversion problems, panel unit root and cointegration techniques have been proposed. Studies such as Holmes (2000), Pedroni (2001), Cerrato and Sarantis (2008), Chortareas and Kapetanios (2009), and Caporale and Hanck (2010) have used these techniques to test the PPP. However, panel tests introduce contemporaneous correlation of error across units (see Strauss and Yigit, 2003), which means the tests statistics may be biased, and hence unreliable PPP evidence.…”

Testing PPP for the South African Rand/US Dollar Real Exchange Rate at Different Data Frequencies

“…Moreover, at times they exhibit erratic behaviour, suggesting the presence of endemic instability (see Caporale et al, 2003 andHanck, 2009 the latter finding that this also characterizes cointegration tests, and therefore is not due to arbitrarily imposed symmetry/proportionality restrictions); however, adjusting the residuals for non-normality and heteroscedasticity using a wild bootstrap method attenuates this type of behaviour considerably (see Caporale and Gregoriou, 2009), and the latter disappears almost completely if panel tests are performed, the evidence for PPP becoming much stronger (see Caporale and Hanck, 2010).…”