Complutense University Library

Non-linear adjustment to purchasing power parity: an analysis using Fourier approximations

Jiménez Martín, Juan Ángel and Robles Fernández, María Dolores (2005) Non-linear adjustment to purchasing power parity: an analysis using Fourier approximations. [Working Paper or Technical Report]


Official URL:

View download statistics for this eprint

==>>> Export to other formats


This paper estimates the dynamics of adjustment to long run purchasing power parity (PPP) using data for 18 mayor bilateral US dollar exchange rates, over the post-Bretton Woods period, in a non-linear framework. We use new unit root and cointegration tests that do not assume a specific non-linear adjustment process. Using a first-order Fourier approximation, we find evidence of non-linear mean reversion in deviations from both absolute and relative PPP. This first-order Fourier approximation allows us to capture many features of the nonlinear decay detected in the data. Our results are consistent with theoretical arguments on
international goods markets arbitrage under transaction costs as well as with an emerging strand of empirical literature. In this sense, this paper contributes towards forming a consensus on the presence of nonzero transaction costs across a broad range of countries.

Item Type:Working Paper or Technical Report
Additional Information:F31, C22, C32
Uncontrolled Keywords:Unit-root test, Cointegration test, Fourier approximation, Nonlinear model, Exchange rates, Purchasing power parity
Subjects:Social sciences > Economics > Econometrics
Series Name:Documentos de Trabajo del Instituto Complutense de Análisis Económico (ICAE)
ID Code:7901

Amara, J., D. Papell (2003). “Testing for purchasing power parity using stationary covariates”, working paper, Department of Economics, University of Houston.

Baum, C. F., J. T. Barkoulas and M. Caglayan (2001). “Non-linear adjustment to purchasing power parity in the post-Bretton Woods era.” Journal of International Money and

Finance, 20, 379-399.

Cheung, Y. W., K. S Lai and M. Bergman, (2004). “Dissecting the PPP puzzle: The unconventional roles of nominal exchange rate and price adjustments”, Journal of International Economics 64, 135-150.

Cheung, Y. W., K. S Lai and S. Kon, (1998). “Parity reversion in real exchange rates during the post-Bretton Woods period”, Journal of International Money and Finance, 18, 751-768.

Corbae, D. and S. Ouliaris (1988). “Cointegration and tests of purchasing power parity.” Review of Economics and Statistics, 70, 508-521.

Davidson, R. and J. MacKinnon (1993). Estimation and Inference in Econometrics. Oxford University Press, Oxford.

Diebold, F., S. Husted, and M. Rush (1991). “Real exchange rate under the gold standard.” Journal of Political Economy, 99, 1151-1158.

Dumas, B. (1992). “Dynamic equilibrium and the real exchange rate in a spatially separated world.” Review of Financial Studies, 5, 153-180.

Frankel, J. and A. Rose (1996). “A panel project on purchasing power parity: mean reversion within and between countries.” Journal of International Economics, 40, 209-24.

Edison, H. J. and E. Fisher (1991). “A long-run view of the European monetary system.” Journal of International Money and Finance, 10, 53-70.

Elliott, G., T. J. Rothenberg and J. H. Stock (1996). “Efficient tests for an autoregressive unit root.” Econometrica, 64, 813–836.

Enders, W. and J. Loudlow (2002). “Non-linear decay: Tests for an attractor using a Fourier approximation.” Working Paper 01-02-02, University of Alabama.

Engel, M. K. Hendrickson and J. H. Rogers (1997). “Intra-national, intra-continental and intra-planetary PPP.” International Finance Discussion Papers, 589, Washington DC:

Board of Governors of the Federal Reserve System.

Engle, R. and C. Granger (1987). “Co-integration and error correction: representation, estimation, and testing.” Econometrica, 55, 251-276.

Granger, C. (1986). “Developments in the study of cointegrated variables.” Oxford Bulletin of Economics and Statistics, 48, 213-228.

Grilli, V. and G. Kaminsky (1991). “Nominal exchange rate regimes and the real exchange rate: evidence for the United States and Great Britain, 1885-1986.” Journal of Monetary Economics, 27, 191-212.

Koedijk, K., P. Schotman, and M. Van Dijk (1998). “The re-emergence of PPP in the 1900’s”, Journal of International Money and Finance, 17, 51-61.

Liu, P. C., and G. S. Maddala (1996). “Do panel data cross-country regressions rescue purchasing power parity (PPP) theory?.” Working Paper, Department of Economics, Ohio State University.

Lothian, J. (1997). “Multi-country evidence on the behaviour of purchasing power parity.” Journal of International Money and Finance, 16, 19-35.

MacKinnon, J. G. (1996). “Numerical distribution functions for unit root and cointegration tests.” Journal of Applied Econometrics, 11, 601-618.

Meese, R. and K. Rogoff (1988). “Was it real? The exchange rate interest differential relation over the modern floating exchange rate period.” Journal of Finance, 43, 933-48.

Michael, P., A. Nobay and D. Peel (1997). “Transaction costs and non-linear adjustments in real exchange rates: an empirical investigation.” Journal of Political Economy 105,


O’Connell, P. G. J. (1998). “The overvaluation of purchasing power parity.” Journal of International Economics, 44, 1-19.

O’Connell, P. and S. Wei. (2002) “The bigger they are the harder they fall.” Journal of International Economics, 56, 21-53.

Obstfeld, M. and A. Taylor (1997). “Non-linear aspects of goods-market arbitrage and adjustment: Heckscher’s commodity point revisited.” Journal of Japanese and International Economics, 11, 441-479.

Oh, K. Y. (1996). “Purchasing power parity and unit root tests using panel data.” Journal of International Money and Finance, 15, 405-18.

Papell, D. H. (1997). “Searching for stationarity: purchasing power parity under the current float.” Journal of International Economics, 43, 313-32.

Papell, D. H. and H. Theodoridis (1998). “Increasing evidence of purchasing power parity over the current float.” Journal of International Money and Finance, 17, 41-50.

Pedroni, P. (1997). “Panel cointegration: asymptotic and finite sample properties of pooled time series tests with an application to the PPP hypothesis (new results).” Working

paper, Department of Economics, Indiana University.

Perron, P. and G. Rodríguez, (2001). “Residual based test for cointegration with GLS detrended data.” PhD dissertation, University of Montreal.

Sercu, P., R. Uppal, C. Van Hull, (1995). “The exchange rate in the presence of transaction costs: implications for tests of purchasing power parity.” Journal of Finance, 50, 1309–1319.

Taylor, A. (1996). “International capital mobility in history: purchasing-power parity in the long run.” Working Paper 5742. National Bureau of Economic Research, Cambridge,


Tong, H. (1990). Non-linear Time Series. Oxford University Press, Oxford.

Uppal, R. (1993). “A general equilibrium model of international portfolio choice.” Journal of Finance, 48, 529–553.

Wu, Y. (1996). “Are real exchange rates non-stationary? Evidence from a panel data test.” Journal of Money, Credit and Banking, 28, 54-63.

Deposited On:22 May 2008
Last Modified:06 Feb 2014 07:56

Repository Staff Only: item control page