The Choice of Numeraire Currency in Panel Tests of Purchasing Power Parity

David H. Papell · Hristos Theodoridis

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Monetary Policy and Economic Impact Financial Markets and Investment Strategies Global Financial Crisis and Policies

Abstract

We investigate the implications of the choice of numeraire currency on panel tests of Purchasing Power Parity under the current regime of flexible exchange rates by conducting panel unit root tests with twenty-one different base currencies. We show that the conditions necessary for numeraire irrelevancy are not supported empirically, and that the choice of numeraire currency can and does matter for PPP. The evidence of PPP is stronger for European than for non-European base currencies. Distance between the countries and volatility of the exchange rates are the most important determinants of the results.

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References

2002Unit root tests in panel data: asymptotic and finite-sample properties 1999A Comparative Study of Unit Root Tests with Panel Data and a New Simple Test 2010Critical Values for Cointegration Tests 1991Pitfalls and Opportunities: What Macroeconomists Should Know about Unit Roots 1998The overvaluation of purchasing power parity 1990Purchasing Power Parity in the Long Run 1996A panel project on purchasing power parity: Mean reversion within and between countries 1995Testing for Unit Roots in Heterogeneous Panels

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2013Inference on stochastic time-varying coefficient models 2002The great appreciation, the great depreciation, and the purchasing power parity hypothesis 1998Increasing evidence of purchasing power parity over the current float 2006Purchasing power parity and country characteristics: Evidence from panel data tests 2006Unbiased Estimation of the Half-Life to PPP Convergence in Panel Data 2004

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