Is the relationship between prices and exchange rates homogeneous?

Hall, Stephen G.; Hondroyiannis, George; Kenjegaliev, Amangeldi; Swamy, P. A. V. B.; Tavlas, George S.

Abstract

Empirical tests of purchasing power parity (PPP) are implicitly based on the conditions of symmetry and proportionality of the price coefficients. We investigate a separate condition, which we term homogeneity. Specifically, while there may be factors that drive a wedge between prices and exchange rates, when these factors are held constant we would expect a change in exchange rates to be associated with a proportional, or homogeneous, change in prices. To test for the existence of homogeneity in prices, we conduct two experiments. First, we apply a time-varying-coefficient procedure to nine euro-area countries as well as the euro area as a whole during the (monthly) sample period, 1999:M1 to 2011:M3. Second we apply the same procedure to the same group of countries, plus Canada, Japan and Mexico, over the longer period, 1957:M4 to 2011:M3. We find that averages of the price coefficients, corrected for specification biases, are uniformly homogeneous in the long run, providing strong support for PPP.

Citation

Hall, S. G., Hondroyiannis, G., Kenjegaliev, A., Swamy, P. A. V. B., & Tavlas, G. S. (2013). Is the relationship between prices and exchange rates homogeneous?. Journal of International Money and Finance, 37, 411-438. https://doi.org/10.1016/j.jimonfin.2013.06.014

• Online Publication Date: Jul 3, 2013
• Publication Date: Oct 1, 2013
• Deposit Date: Nov 13, 2014
• Publicly Available Date: Nov 23, 2017
• Journal: Journal of international money and finance
• Print ISSN: 0261-5606
• Publisher: Elsevier
• Peer Reviewed: Peer Reviewed
• Volume: 37
• Pages: 411-438
• DOI: https://doi.org/10.1016/j.jimonfin.2013.06.014
• Keywords: Purchasing power parity; Symmetry; Proportionality; Homogeneity; Generalized cointegration; Time-varying coefficients
• Public URL: https://hull-repository.worktribe.com/output/470916
• Publisher URL: http://www.sciencedirect.com/science/article/pii/S0261560613000879
• Additional Information: Author's accepted manuscript of article published in: Journal of international money and finance, 2013, v.37
• Contract Date: Nov 23, 2017