Are real exchange rates of Papua New Guinea mean-reverting? Evidence from panel unit root tests

Abstract

This article examines mean-reversion of real exchange rates of Papua New Guinea (PNG), which is the crucial condition for purchasing power parity (PPP) to hold. Taking a departure from the most previous studies, we used six panel unit root tests to investigate the empirical validity of the PPP hypothesis to PNG. Both the preliminary analysis performed by examining time series plots of real exchange rates and the results of the panel unit root tests indicate that the PPP does not hold for PNG. These results may be attributed to frictions, such as transportations costs, prevailing in international trade that lead PPP to follow a nonlinear stochastic process. This issue will be investigated in future research.

Notes

¹ See, Taylor (2003) and Taylor and Taylor (2004) for excellent surveys on previous studies on PPP.

² Taylor (1988) was the first to use unit root tests in testing PPP.