Long-run purchasing power parity with asymmetric adjustment: further evidence from China

Abstract

This study applies threshold cointegration test advanced by Enders and Siklos (2001) to investigate the properties of asymmetric adjustment in long-run Purchasing Power Parity (PPP) for China during the period of March 1985 to September 2008. Although there is evidence of long-run PPP for China, when both the United States and Japan are served as the base country, the adjustment mechanism is asymmetric only when the United States is served as the base country. These results have particularly important policy implications for China.

Notes

¹Other reasons for the asymmetric adjustment are the presence of transaction costs that inhibit international goods arbitrage and official intervention in the foreign exchange market may be such that nominal exchange rate movements are asymmetric (see, Sarno and Taylor, 2001; Reitz and Taylor, 2008). Killian and Taylor (2003) also suggest that nonlinearity may arise from the heterogeneity of opinion in the foreign exchange market concerning the equilibrium level of the nominal exchange rate: as the nominal rate takes on more extreme values, a great degree of consensus develops concerning the appropriate direction of exchange rate moves, and traders act accordingly.