Purchasing power parity in major OPEC countries: nonlinear threshold unit root test

Abstract

This study applies nonlinear threshold unit root test to assess the nonstationary properties of the Real Exchange Rate (RER) for seven major Organization of the Petroleum Exporting Countries (OPEC). We found that nonlinear threshold unit root test has higher power than linear method suggested by Caner and Hansen (2001) if the true data-generating process of exchange rate is in fact a stationary nonlinear process. We examined the validity of Purchasing Power Parity (PPP) from the nonlinear point of view and provided robust evidence clearly indicating that PPP holds true for three countries, namely Angola, Indonesia and Iran. Our findings point out that their exchange rate adjustment is mean reversion towards PPP equilibrium values in a nonlinear way.