Non-normality, heteroscedasticity and recursive unit root tests of PPP: solving the PPP puzzle?

Abstract

In this article, we carry out unit root tests on real exchange rates recursively as in Caporale et al. (2003), but, following Arghyrou and Gregoriou (2007), we adjust the residuals for non-normality and heteroscedasticity using a wild bootstrap method. The results are striking: this correction sharply increases the rejection percentages of the unit root null and attenuates the erratic behaviour of the t-statistic, providing evidence in favour of purchasing power parity (PPP) and suggesting that such a correction might at least go some way towards solving the ‘PPP puzzle’.

Notes

¹Similar results are reported in the case of trivariate cointegration tests by Caporale and Hanck (2008).

²The analysis was also carried out using PPI data; these results, qualitatively similar, are available from the authors upon request.

³A very similar pattern is observed for the other countries. The corresponding figures are available upon request.