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Journal of Business & Economic Statistics Volume 11, 1993 - Issue 1
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Original Articles

A Fractional Cointegration Analysis of Purchasing Power Parity

Yin-Wong Cheung Department of Economics, Crown College, University of California, Santa Cruz, CA, 95064
&
Kon S. Lai Department of Economics, School of Business and Economics, California State University, Los Angeles, CA, 90032
Pages 103-112 | Published online: 02 Jul 2012
 
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Abstract

A generalized notion of cointegration, called fractional cointegration, is introduced to examine the long-run purchasing power parity (PPP) hypothesis. By allowing deviations from equilibrium to follow a fractionally integrated process, the fractional cointegration analysis can capture a wider range of mean-reversion behavior than standard cointegration analyses. This gain is flexibility in modeling subtle mean-reverting dynamics is found to be important for a proper evaluation of long-run PPP. Empirical results based on historical data for the 1914–1989 period show that PPP reversion exists and can be characterized by a fractionally integrated process in three out of five countries studied. The results support PPP as a long-run phenomenon, though significant short-run deviations from PPP can exist.

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