Long-Run PPP Under the Presence of Near-to-Unit Roots: The Case of the British Pound-US Dollar Rate

12 Pages Posted: 27 Apr 2009

See all articles by Nikitas Pittis

Nikitas Pittis

University of Piraeus - Department of Banking and Financial Management

Sarantis C. Kalyvitis

Athens University of Economics and Business - Department of International and European Economic Studies

Christis Hassapis

University of Cyprus

Abstract

Empirical tests typically provide evidence that the British pound-US dollar exchange rate and the relative wholesale price index contain exact unit roots and exhibit cointegration. However, the cointegrating vector is significantly different from [1, -1], thus raising doubts on the validity of the purchasing power parity (PPP) hypothesis. Following Elliott (1998), we show that if the exchange rate and relative price series contain near-to-unit roots in the context of a bivariate system, then any inference on the "cointegrating" vector and consequently on PPP, which is based on standard cointegration estimation methods, will be misleading. We then argue that the existing evidence against the PPP hypothesis in the British pound-US dollar market can be attributed to the finite sample bias of the standard cointegration estimators, arising from an endogenous and "nearly" nonstationary regressor. We also show that when robust procedures are employed the evidence favors the PPP hypothesis.

Suggested Citation

Pittis, Nikitas and Kalyvitis, Sarantis C. and Hassapis, Christis, Long-Run PPP Under the Presence of Near-to-Unit Roots: The Case of the British Pound-US Dollar Rate. Review of International Economics, Vol. 17, Issue 1, pp. 144-155, February 2009, Available at SSRN: https://ssrn.com/abstract=1395450 or http://dx.doi.org/10.1111/j.1467-9396.2008.00809.x

Nikitas Pittis (Contact Author)

University of Piraeus - Department of Banking and Financial Management ( email )

80 Karaoli & Dimitriou Str.
18534 Piraeus, 185 34 -GR
Greece

Sarantis C. Kalyvitis

Athens University of Economics and Business - Department of International and European Economic Studies ( email )

Patission Str 76
GR-10434 Athens
Greece

Christis Hassapis

University of Cyprus ( email )

75 Kallipoleos Street
P.O. Box 20537
1678 Nicosia
Cyprus
+357-2-892116 (Phone)
+357-2-750310 (Fax)

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