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Purchasing power parity during currency crises: a panel unit root test under structural breaks.

  • Economics


Purchasing Power Parity during Currency Crises: A Panel Unit Root Test under Structural Breaks Jörg Breitung and Bertrand Candelon University of Bonn; Maastricht University Abstract: We investigate the stationarity of real exchange rates using a panel of Asian and South and Latin American countries by applying a new panel unit root test that is robust to structural breaks due to currency crises. It turns out that the long-run PPP relationship is relevant for the Asian countries, which experi- enced a flexible exchange rate, whereas for the South and Latin American coun- tries, for which the exchange rate has been pegged to the U.S. dollar for a long time, the PPP relationship breaks down. In Asian countries PPP appears to hold before the 1997 crisis, which is not the case for the South and Latin American countries. This suggests that the “Asian flu” corresponds to a second-generation type of crises, whereas the 1995 “Mexican tequila” fits the first-generation models better. JEL no. C13, C33, E41 Keywords: Panel data; unit root tests; structural breaks; PPP; currency crisis 1 Introduction For many years, the empirical analysis of the purchasing power parity (PPP) has constituted an active research area. In this literature the equilibrium exchange rate is often associated with an international version of the law of one price. The standard approach to testing for an equilibrium real exchange rate is to apply unit root tests such as the one suggested by Dickey and Fuller (1979). If the test cannot reject the null hypothesis of a unit root in the logarithm of real exchange rate, then deviations of the PPP relationship are considered to be permanent. Applying such tests to post- 1973 data reveals however little support for the PPP paradigm. Papell (1997) Remark: The research for this paper was carried out within the DFG research project “Unit roots and cointegration in panel data” and the METEOR research project “Macroeconomic Consequences of Financial Crises” at the University of Maastr

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