PPP and nonlinearity of real exchange rates: new evidence from transition economies

Abstract

In this article, we investigate the Purchasing Power Parity (PPP) concept by utilizing a database of monthly real exchange rates from 12 Central and Eastern European economies with respect to different numeraire currencies. Owing to the elaborated limitations of linear specifications by verifying this exchange rate theory, we apply a nonlinear unit root test based on the Exponential Smooth Transition Autoregressive (ESTAR) model proposed by Kapetanios et al. (KSS; 2003). Our analysis shows that after taking into account the nonlinear reversion of real exchange rates of European transition economies with respect to the euro, the validity of PPP is confirmed for the majority of countries in the sample.

Keywords:

• purchasing power parity
• nonlinear unit root test
• stationarity
• real exchange rates

JEL Classification:

• C22
• E31
• F31
• F40