Journal Article

No. 2008-7 | March 13, 2008
Uncover Latent PPP by Dynamic Factor Error Correction Model (DF-ECM) Approach: Evidence from Five OECD Countries PDF Icon

Abstract

This study explores a new modelling approach that bridges the gap between multilateral country-level data and the bilateral-model based, goods-market specific purchasing power parity (PPP) hypothesis. Under this approach, PPP is embedded in latent common factors, extractable from a large set of bilateral price disparities, and tested via an error-correction model where the factors act as error-correction leading indicators for exchange rate and inflation. Significant modelling results for five OECD countries using monthly data suggest that the extant finding of insignificant PPP using similar data should be due to errors-in-variables attenuation and that its correction lies in effective construction of latent variables.

JEL Classification

C22 C33 F31

Citation

Duo Qin (2008). Uncover Latent PPP by Dynamic Factor Error Correction Model (DF-ECM) Approach: Evidence from Five OECD Countries. Economics: The Open-Access, Open-Assessment E-Journal, Vol. 2, 2008-7. http://dx.doi.org/10.5018/economics-ejournal.ja.2008-7

Assessment

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