Parity Reversion in Real Exchange Rates: Fast, Slow Or Not at All?
Consensus estimates put the half-life of deviations from purchasing power parity (PPP) at about four years (Rogoff, 1996). However, conventional least squares estimates of half-lives are biased downward. Accordingly, as a preferred measure of the persistence of real exchange rate shocks, this study uses median-unbiased estimators of the half-life of deviations from parity, which correct for the downward bias of conventional estimators. The paper tests for PPP using real effective exchange rate data for 90 developed and developing countries in the post-Bretton Woods period. Support for PPP is found, as the majority of countries experience finite deviations of real exchange rates from parity. The speed of parity reversion is found to be typically much faster for developed countries than for developing countries, and to be considerably faster for countries with flexible nominal exchange rate regimes in comparison with countries having fixed nominal exchange rate regimes.
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What Is Causing the Heterogeneous Persistence of Deviations from Parity?
3A Frequency Distribution of MedianUnbiased HalfLives of Deviations from
50 percent probability Andrews and Chen approximate p-value AR(p autoregressive parameter Average half-life average median bias Burkina Faso calculated Central African Republic Cheung classification Countries with Annual country groups country’s cross-country heterogeneity dejure developing countries deviations from parity deviations from PPP effective exchange rate Exchange Rate Countries exchange rate regimes exchange rate shocks external financing GDP per capita half-life of parity Half-lives of Deviations IMF AREAER IMF’s impulse response impulse response function inflation least squares estimates median-unbiased estimation Median-Unbiased Half-lives Nigeria nominal exchange rate null hypothesis p-value parity deviations parity reversion Permanent Half-life persistence of parity persistence of real post-Bretton Woods period PPP holds Purchasing Power Parity real effective exchange real exchange rate REER Reinhart and Rogoff Reinhart-Rogoff 2002 Republic of Congo reversion of real sample speed of parity Togo true half-life U.S. dollars unbiased model-selection rule unit root World Bank 2002 Zambia