Revisiting purchasing power parity for East Asian countries: sequential panel selection method

Abstract

This study applies the Sequential Panel Selection Method (SPSM) procedure proposed by Chortareas and Kapetanios (2009) to test the validity of long-run Purchasing Power Parity (PPP) for a sample of East Asian countries over the period March 1985 to September 2011. SPSM classifies the whole panel into a group of stationary series and a group of nonstationary series. In doing so, we can clearly identify how many and which series in the panel are stationary processes. Empirical results from the SPSM using the Panel Kapetanios et al. (KSS) unit root test (Ucar and Omay, 2009) with a Fourier function indicate that PPP holds true for most of these East Asian countries studied, with the exception of Hong Kong. Our results have important policy implications for these East Asian countries under study.

Keywords:

• purchasing power parity
• East Asian countries
• sequential panel selection method
• Panel KSS unit root test
• Fourier function
• policy implications

JEL Classification:

• C22
• F31

Notes

¹ Empirical evidence of Purchasing Power Parity (PPP) on the stationarity of the real exchange rate is abundant, but unfortunately, thus far, the consensus has not yet reached. For details about previous studies, see the work of Taylor (1995), Rogoff (1996), Taylor and Taylor (2004), Taylor (2006), Lothian and Taylor (2008) and Juvenal and Taylor (2008), who have provided in-depth information on the theoretical and empirical aspects of PPP and the real exchange rate.

² The asymptotic p-values are computed by means of bootstrap simulations using 5000 replications.

³ Several conventional unit root tests are also employed in our study. With one exception, we found that the unit root null hypothesis was rejected for Indonesia when both the Augmented Dickey–Fuller (ADF) and Phillips–Perron (PP; 1988) tests were conducted. These results imply that PPP did not hold for most of these 10 East Asian countries during the sample period. To save space, we do not report the results but available upon requests.

⁴ If we look at the results of the individual Kapetanios et al. (KSS) unit root test on the real exchange rates (see Column 3 of Table 1), the KSS unit root test only reject the unit root hypothesis for six countries (i.e. Indonesia, Malaysia, Japan, Thailand, China and Taiwan).