Can purchasing power parity help forecast the dollar?

The information on future exchange rate movements provided by the doctrine of purchasing power parity (PPP) is examined. A recent study focuses on the durations of periods in which exchange rates deviate from their PPP levels. If PPP provides information about future exchange rate movements, these d...

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Journal Title: Journal of forecasting Vol. 14; no. 6; pp. 523 - 532
Author: Steven J. Cochran
Format: Article
Published: 1995
Subjects:
Summary: The information on future exchange rate movements provided by the doctrine of purchasing power parity (PPP) is examined. A recent study focuses on the durations of periods in which exchange rates deviate from their PPP levels. If PPP provides information about future exchange rate movements, these durations should exhibit positive duration dependence. That is, the probability of returning to PPP levels should increase as the period of deviation increases. Parametric hazard functions estimated using data from 18 countries provide no evidence of positive duration dependence. These results are robust to alternative definitions of PPP and to alternative functional specifications. PPP provides no useful information on future exchange rate changes, a result consistent with market efficiency.
ISSN: 0277-6693