Empirical investigation of long run ppp hypothesis: the case of temporary structural break and asymmetric adjustment

Abstract

This study investigates the validity of the long-run PPP hypothesis for 60 economies using trade-weighted REER indices for the period 1994:01-2020:04. In addition to conventional tests, we also apply a battery of new unit root tests that allow for structural breaks and nonlinear adjustment. Our results suggest that test procedures that allow for both a structural break in the deterministic components of the series and nonlinearities in the adjustment towards equilibrium lead to a more frequent rejection of the unit root null hypothesis. In particular, after allowing for a temporary structural break in the series along with nonlinear adjustment towards the gradually changing equilibrium, we were able to reject the null hypothesis of unit root for all countries, thus providing some support for the PPP hypothesis.