Purchasing power parity nonlinear threshold unit root test for East-Asian countries

Abstract

This study applies the Threshold Autoregressive (TAR) model proposed by Caner and Hansen (2001) to test the validity of long-run Purchasing Power Parity (PPP) of nine East-Asian countries over the period January 1986 to October 2009. The empirical results indicated that PPP holds true for more than half of these nine East-Asian countries under study, and the adjustment towards PPP is found to be nonlinear.

Keywords:

• purchasing power parity
• East-Asian countries
• nonlinear threshold unit root test

JEL Classification:

• C22
• F31

Acknowledgements

We are grateful to Bruce Hansen for making available his Matlab codes for the TAR model, which were modified for this exercise. However, any remaining errors are our own.

Notes

¹ Reasons for the nonlinear adjustment are the presence of transactions costs that inhibit international goods arbitrage and official intervention in the foreign exchange market may be such that nominal exchange rate movements are asymmetric (Taylor and Peel, 2000; Taylor, 2004; Juvenal and Taylor, 2008). Kilian 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 as accordingly.

² Since R _1T has more power than that of R _2T , we only report the results of R _1T in our study.