Borderplex menu evidence for the law of one price: a convergence approach

Abstract

A convergence approach is utilized to examine deviations from the law of one price. Sample data are menu prices for eight identical products sold by international restaurant franchises in Mexico and the United States. The results suggest mean reverting behaviour in real exchange rate movements in response to recent information.

Acknowledgements

Thomas Fullerton's research was supported by National Science Foundation Grant SES-0332001, El Paso Electric Company, Hunt Building Corporation, El Paso Metropolitan Planning Organization and Wells Fargo Bank of El Paso. Research assistance to Thomas Fullerton by Brian Kelley, Marycruz De Leon and George Novela is also gratefully acknowledged.

Notes

¹ In particular, Caselli et al. (1996) used a τ-order transformation of Equation 3(3) so that the regression equation is q_it  − q_{i , t −τ} = β*(q_{i , t −τ} − q_{i , t −2τ}) + ε _it  − ε _{i , t −τ}. They used q _{i, t − 2τ} , q _{i, t − 3τ} , ⋯ as instruments to estimate β*.

² We use the Schwarz information critetion to select the lag length in the augemented Dickey–Fuller test.

³ We may also be interested in calculating the half-life of q_it in response to a shock that happens τ months ago. For τ = 5, 10, 25, the estimated half-lives based on are 0.3040, 0.1637, 0.1593, respectively.