Investigation of the nonlinear behaviour in real exchange rates in developing regions

ABSTRACT

This article examines whether the purchasing power parity (PPP) theory holds or not for the economies in different developing regions located in Africa, Asia and Latin America. In order to investigate this issue, a nonlinear panel unit root test is used to determine if some or all of the real exchange rates in a panel follow a stationary exponential smooth transition autoregressive process. By applying the nonlinear panel unit root test, our results demonstrate an empirical support for the theory of PPP for the economies in developing regions.

KEYWORDS:

• Purchasing power parity
• ESTAR
• panel data
• developing regions

JEL CLASSIFICATION:

• C23
• F41
• F31

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ However, such factors as the existence of trade barriers (tariff and non-tariff barriers), transportation costs and product differentiation across countries create a wedge between the domestic and foreign prices, thus lead to a failure of the absolute purchasing power parity (PPP).

² The PPP puzzle regards reconciliation of the extremely low speed of adjustment of the real exchange rate with the enormous short-run volatility (Rogoff 1996).

³ See the simulation study conducted by Månsson (2013) for details.