Black and official market exchange rates and purchasing power parity: evidence from Latin America

Abstract

A group of studies have shown that in less developed countries, Purchasing Power Parity (PPP) theory is supported more often when black market exchange rates rather than official rates are used in the testing procedure. They have all relied upon linear Augmented Dickey–Fuller (ADF) test applied either to the residuals of a cointegrating vector or to real exchange rates. In this article, we use a nonlinear ADF test and show that when nonlinearity is incorporated in the testing procedure, the nonlinear tests support PPP more often than the linear test regardless of whether we use official or black market exchange rate. Besides, for the post-Bretton Woods period, PPP is almost equally supported using either the black market exchange rates or the official rates.

Acknowledgement

Valuable comments of two anonymous referees are greatly appreciated without, of course, implicating them.

Notes

¹Taylor et al. (2001), Liew et al. (2004), Chortareas and Kapetanios (2004), Sarno et al. (2004) and Bahmani-Oskooee et al. (2007) are examples of other studies that have applied nonlinear tests to PPP.

²For such a model, see Michael et al. (1997) and Juvenal and Taylor (2008).

³Another reason for the presence of nonlinear ties in both nominal and real exchange rates could be the interaction of technical and fundamental traders or disagreement between fundamentalists with regard to the proper equilibrium rate. Technical traders may drive the exchange rate away from equilibrium, and only when it is too far away, do all of the fundamentalists agree that it is too far away and take action to change the course. For more details see Allen and Taylor (1990), Kilian and Taylor (2003), Taylor (2004), Menkhoff and Taylor (2007) and Reitz and Taylor (2008).

⁴They include Culbertson (1975), Phillip (1988), Bahmani-Oskooee (1993), El-Sakka and McNaab (1994), Baghestani (1997), Sanchez-Fung (1999), Luintel (2000), Bahmani-Oskooee and Goswami (2005) and Bahmani-Oskooee and Tanku (2007). For a comprehensive review of these studies and other PPP-related studies in all developing countries see Bahmani-Oskooee and Hegerty (2009). See also Macdonald and Taylor (1992) for another useful review of general issues.

⁵For some other exchange-related and PPP issues, see Moosa (1994), Beach et al. (1993), Bleaney (1992), Horne (2004), Baffoe-Bonnie (2004), Arize et al. (2002), Holmes (2002), Apergis (1998), Jung (1995), Hojman (1989), Bahmani‐Oskooee (1999) and Sjolander (2007).

⁶This section closely follows Bahmani-Oskooee et al. (2007).

⁷See Table 1 for a list of countries.

⁸Because of the lack of some observations, the study periods for Dominican Republic, El Salvador and Venezuela were restricted to 1960:03–1998:12, 1961:1–1998:12 and 1960:11–1998:12, respectively.

⁹A possible extension of the tests for nonlinearity might incorporate allowance for shifts in the equilibrium rate itself, perhaps, due to productivity bias hypothesis. This might be particularly important for developing countries. For more details, see Lothian and Taylor (2000, 2008) and Bahmani-Oskooee and Miteza (2004). For a review article on productivity bias hypothesis, see Bahmani-Oskooee and Nasir (2005).