Purchasing power parity with threshold effects for Central and Eastern European countries

Abstract

This study applies nonlinear threshold unit-root test to assess the nonstationarity properties of the Real Exchange Rate (RER) for seven Central and Eastern European Countries (CEEC). We find 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 examine the validity of Purchasing Power Parity (PPP) from the nonlinear point of view and provide robust evidence that clearly indicates that PPP holds true for three countries, namely Slovakia, Romania and Bulgaria. Our findings point out their exchange rate adjustment mean-reverts towards PPP equilibrium values in a nonlinear way.

Keywords:

• nonlinear threshold unit-root test
• purchasing power parity

JEL Classification:

• C22
• F31