This paper “An empirical evaluation of the Purchasing Power Parity” analyses the empirical validity of the purchasing power parity theory, the notion that the exchange rate between two countries is determined by the relative price levels in these two countries…
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In pursuit of investigating the empirical validity of the PPP theory, this study uses the monthly Japanese Yen to US Dollar exchange rate and the seasonally adjusted Japanese and US monthly Consumer Price Index series as the representative of the price levels as available from OECD main economic indicators 2010. Our data set covers a sample period ranging from 1st January1960 to 1st June 2010. The indexing of CPI for both the Japanese and US series is in accordance with assuming the price level of 2005=100. 5. Estimation This section presents the results of the estimations specified in section 2. We start of by presenting the statistical preliminaries and time series plots of the variables to engender a preconception of what can be expected from the estimated equations. a. Statistical preliminaries Table 1 presents the summary statistics for the variables of interest. Note that these are expressed in terms of natural logarithms of the levels. Figure 1 below depicts the inter-temporal dynamics of the natural logarithm of the series of Japanese Yen to US Dollar Exchange rates. Observe that the series provides a clear visual evidence of a downward trend implying that over the period of 1970 to 2011, there has been a gradual decline in the exchange rate. Additionally, the series also appears to be non-stationary. Of course stationarity properties can only be conclusively verified after formal conduction of unit root tests. Figure 3 presents the time plots of Japanese and US consumer price indices in logs.... tion: where is the natural log of the Japanese Yen to US Dollar exchange rate at time t, is the natural log of the price level index of Japan and is the natural log of the price level index of USA and is an additive iid noise term. 3. Testable Hypothesis The hypotheses that we can test using this specification are as follows: i) Strong or absolute PPP: ii) Relatively weaker form of PPP: ? iii) Weakest form of PPP: ? Note that for ii) and iii) to be valid specifications, the additive error term will have to be stationary. Otherwise estimates will be spurious. 4. Data In pursuit of investigating the empirical validity of the PPP theory, this study uses the monthly Japanese Yen to US Dollar exchange rate and the seasonally adjusted Japanese and US monthly Consumer Price Index series as the representative of the price levels as available from OECD main economic indicators 2010. Our data set covers a sample period ranging from 1st January1960 to 1st June 2010. The indexing of CPI for both the Japanese and US series is in accordance with assuming the price level of 2005=100. 5. Estimation This section presents the results of the estimations specified in section 2. We start of by presenting the statistical preliminaries and time series plots of the variables to engender a preconception of what can be expected from the estimated equations. a. Statistical preliminaries Table 1 presents the summary statistics for the variables of interest. Note that these are expressed in terms of natural logarithms of the levels. Table 1: Summary Statistics of the variables of interest Figure 1 below depicts the inter-temporal dynamics of the natural logarithm of the series of Japanese Yen to US Dollar Exchange rates. Observe that the series provides a clear visual evidence of a downward trend
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...?I. PurchasingPowerParity Generating Eviews work file By inspecting the dataset Data_Canada_PPP.xls, it is analysed that the data consists of 3 series Exchange_rate (Canadian dollar to US dollar nominal exchange rate), CPI_Can (Canadian Consumer Price Index) and CPI_US (the US Consumer Price Index) that are observed every month from the year 1990/1 till 2011/3. A new Eviews workfile is generated from the main menu of the Eviews by selecting File/New/Workfile, which opens up the create workfile dialogue box. Dated-regular frequency is chosen as the workfile structure type, frequency is chosen as monthly with the start date as 1990-1 and end date as 2011-03 as shown in fig1. The data from...
...PurchasingPowerParity and the "Big Mac Index" Introduction When we go at a shop to buy something, we expect to get that product at a value we perceive to be associated with it. Also when we travel abroad, we expect the same product to cost us the same value that we get in the home country. Investopedia defines this phenomenon as the PurchasingPowerParity which in economic terms is a "theory that estimates the amount of adjustment needed on the exchange rate between countries in order for the exchange to be equivalent to each currency's purchasingpower."
In other words purchasing...
... between countries continues, there would be an eventual and natural apex of the pricing structure that is only dependent on the trade, and this apex would become a plateau between the two countries, where the price of one product is equal to the price of another.
This expansion forms the basis of the purchasingpowerparity (PPP), where the law has received much of its empirical testing. Taylor and Taylor (2004, p.137) state "[T]he Law of One Price, [abstracting from, or ignoring transport cost] implies that a PPP exchange rate should hold between the countries concerned." Another extension that can further expand the domain of the law is in combining two or more of its applications. For instance, the law then applies not only... to the...
... in the spot market are large commercial banks and non-bank financial institutions. Interbank trading is usually done through brokers, but foreign exchange trading can be done without their aide. However, with the spot exchange rate, the overall strength of the national's currency and major trading partners become at risk.
There are other factors that affect the spot rate, one of which is the PPP, both relative and absolute can be used to determine the equilibrium spot rate. With absolute purchasingpowerparity, the level of the equilibrium spot rate is the level that causes the price of traded goods and services to have the same price in all countries when measured in the same currency. Despite the limited empirical support... The Role...
Balassa, B. (1964). The Purchasing-PowerParity Doctrine: A Reappraisal. Journal of Political Economy. 72: 584-596.
Froot, K.A., and Rogoff, K., (1995), Perspectives on PPP and Long-Run Real Exchange Rates, in Handbook of International Economics, (ed.) Grossman, G. and Rogoff, K., Vol. III, Elsevier Science.
MacDonald, Ronald, (1996), Panel Unit Root Tests and Real Exchange Rates, Economics Letters, 50, 7-11.
Neary, J. Peter (1988). Determinants of the Equilibrium Real Exchange Rate. American Economic Review. 78: 210-215.
Neary, P.J. (2004) PurchasingPowerParity. Prepared for Encyclopedia of World Trade Since...
...PURCHASINGPOWERPARITY By of the of the School Data We collected monthly consumer price index (CPI) time series data spanning from 1st January 1955 to 1st December 2013 from the Federal Reserve Economic Data. We however manipulated the data to have them in annual form and computed PurchasingPowerParity (PPP) using 2002 as the index (base) year. We used data from UK since previous research has shown that they are the most commonly used data set to test for PurchasingPowerParity (PPP).
Before conducting any serious analysis we ran some basic statistics. The...
...of the paper is a design of a framework for testing for the absolute PPP and relative PPP following monetary approach. The second part is a brief summary of the interest rate parity conditions and their underlying logics and implications. This displays the application of the exchange rate used in forward contracts differ from the current spot rate. The emphasis is on the reasons for difference between the forward rates and the future spot rate expected by investors.
Part 1: Empirical Study
(Selected Question: Question 2)
1. Test for Long-term PurchasingPowerParity (PPP)
This study investigates the absolute and the relative...
.... Nevertheless, the concerned country lacks the ability of setting monetary policy in regard to other local considerations. In addition, the fixed exchange will rate will, to a greater extent also secure a nation’s trading terms, inspite of economic variations that exist between itself and its trading partners (Pintev, 2003).
2. Purchasingpowerparity (PPP)
Purchasingpowerparity can be described as an element of some economic theories as well as a method that is used in determining the relative value of various currencies. PPP claims that various exchange rates between diverse currencies are in balance when their respective...
...PurchasingPowerParity In the journal, “An Empirical Test of PurchasingPowerParity in Selected African Countries - a Panel Data Approach,” the author discusses the applicability of the PurchasingPowerParity theory in selected African countries. The author, Beatrice K. Mkenda has a vast focus on the panel unit root-test. The paper aims at testing whether the real exchange rates that are depicted are mean reverting or not.
In the article, the author goes through a number of selected African countries, pointing out the application of the Purchasing...
It states that the country which is having high inflation rate is weak in terms of currency because inflation reduces the real purchasing power of a nation’s currency. It predicts a relationship between the inflation rates of two countries over a specified period and the movement in the exchange rate between their two currencies over the same period which means that the exchange rate of two currencies reflects the effect of inflation rate (Murphy, p.1). Absolute PPP states that the value of 2 currencies changes in contrary proportion to the changes in the ratio of price levels. On the other hand relative, PPP predicts a relationship between the inflation rates of two countries over a specified period and the movement in t...
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