Purchasing Power Parity Dynamics
Purchasing Power Parity (PPP) theory has been controversial for some eighty years now. Today, sophisticated econometric techniques allow not only for more powerful tests of its validity than was ever possible in the past, but also for forecasts of nominal exchange rate dynamics to be made. In this paper we have essentially applied Johansen's multi-cointegration technique. After running unit root tests we have checked PPP's validity for 12 couples of countries and computed cointegration vectors. For three couples we have also estimated parsimonious VECMs and performed exogeneity tests. Impulse response analyses have complemented our results. Although our investigations are limited to three exchange rates, the methodology seems promising for understanding nominal exchange rate dynamics.
AFTALION, F. and INDJEHAGOPIAN, J.P. (1996). Purchasing Power Parity Dynamics. In: Forecasting Financial Markets - New Advances for Exchange Rates, Interest Rates and Asset Management. Chemical Bank, Imperial College, pp. 1-9.