Kon S. Lai

A Fractional Cointegration Analysis of Purchasing Power Parity

A generalized notion of cointegration, called fractional cointegration, is introduced to examine the long-run purchasing power parity (PPP) hypothesis. By allowing deviations from equilibrium to follow a fractionally integrated process, the fractional cointegration analysis can capture a wider range of mean-reversion behavior than standard cointegration analyses. This gain is flexibility in modeling subtle mean-reverting dynamics is found to be important for a proper evaluation of long-run PPP. Empirical results based on historical data for the 1914–1989 period show that PPP reversion exists and can be characterized by a fractionally integrated process in three out of five countries studied. The results support PPP as a long-run phenomenon, though significant short-run deviations from PPP can exist.

Lag Order and Critical Values of the Augmented Dickey–Fuller Test

Response surface analysis is used to obtain approximate finite-sample critical values for the augmented Dickey–Fuller (ADF) test. Previous studies estimating the critical values for the test have generally ignored their possible dependence on the lag order. This study shows that the lag order, in addition to the sample size, can affect the finite-sample behavior of the test. The result points to the importance of correcting for the effect of lag order in applying the ADF test.

A search for long memory in international stock market returns

Abstract A major issue in financial economics is the behavior of stock returns over long as opposed to short horizons. This study provides empirical evidence from the perspective of long memory analysis. International evidence on long memory is explored using the Morgan Stanley Capital International stock index data for eighteen countries. Two tests that are robust to short-term dependence and conditional heteroskedasticity are employed: a modified rescaled range test and a fractional differencing test. The empirical results in general provide little support for long memory in international stock returns. The findings are not sensitive to inflation adjustments in stock returns, data sources, and statistical methods used.

On the purchasing power parity puzzle

Abstract A puzzle concerning purchasing power parity is examined: Although the immense exchange rate volatility suggests a likely major role of nominal shocks under sticky prices, the observed half-life persistence of the real exchange rate seems excessively high to be rationalized by price stickiness. This study analyzes carefully the adjustment dynamics of real exchange rates through impulse response analysis. Half-life estimates are found to have substantial imprecision. Moreover, the dynamic response pattern suggests that the shock response is initially amplified before dissipating and that such non-monotonic dynamics can contribute to more than one-third of the observed persistence of real exchange rates.

On Cross-Country Differences in the Persistence of Real Exchange Rates

Previous findings of long-run purchasing power parity come mainly from data for industrial countries, raising the issue of whether the results suffer sample-selection bias and exaggerate the general relevance of parity reversion. This study uncovers substantial cross-country heterogeneity in the persistence of deviations from parity. The results show that it is more likely, rather than less likely, to find parity reversion for developing countries than industrial countries. Although some persistence variations may partly reflect country differences in structural characteristics such as inflation experience and government spending, a considerable portion of those variations seems unaccounted for.

Dissecting the PPP Puzzle: The Unconventional Roles of Nominal Exchange Rate and Price Adjustments

The conventional view, as expounded by sticky-price models, is that price adjustment determines the PPP reversion rate. This study examines the mechanism by which PPP deviations are corrected. Nominal exchange rate adjustment, not price adjustment, is shown to be the key engine governing the speed of PPP convergence. Moreover, nominal exchange rates are found to converge much more slowly than prices. With the reversion being driven primarily by nominal exchange rates, real exchange rates also revert at a slower rate than prices, as identified by the PPP puzzle (Rogoff, 1996).

Parity Reversion in Real Exchange Rates During the Post-Bretton Woods Period

Some recent studies suggest the post-Bretton Woods period offers a sample that is far too short to reveal any significant evidence on purchasing power parity reversion in individual series of real exchange rates. This study shows that the post-Bretton Woods data contain substantial information on parity reversion. Two efficient univariate unit-root tests, which require much shorter sample sizes than conventional tests to attain the same statistical power, are applied to individual real exchange rate series to uncover parity reversion. Empirical results show that an efficient unit-root test yields favorable evidence on parity reversion even during the Bretton-Woods era.

Mean reversion in real exchange rates

A modified Dickey-Fuller test, which is approximately uniformly most power invariant, is employed to examine mean reversion in real exchange rates. Results from this test provide a wider and more significant support for mean reversion than the standard Dickey-Fuller test.

Long memory and nonlinear mean reversion in Japanese yen-based real exchange rates

Abstract The extraordinary difficulty in uncovering parity reversion in yen-based real exchange rates has often been ascribed to a missing trend variable. This study identifies an alternative explanation and shows that the puzzling behavior of real yen rates may stem from long-memory dynamics, which undermine unit-root tests in their ability to detect mean reversion. The long-memory findings are consistent with the long swings in yen exchange rates during the current float. Further analysis also reveals evidence of non-monotonic reversion toward parity.

Government spending and economic growth: the G-7 experience

Buildig on Barros (1990) endogenous growth model, attempts are made to untangle the nature of the relationship between government expenditure and economic growth by examining the intertemporal interactions among the growth rate in per capita real GDP, the share of government spending, and the ratio of private investment of GDP for the Group-of-Seven countries. A multivariate time series analysis is conducted, with particular attention paid to the causal pattern and the shape of impulse-response function in the context of vector autoregressions. The analysis is based on the historical data for the Group-of-Seven countries. The empirical results suggest that the relationship between government spending and growth can vary significantly across time as well as across the major industrialized countries that presumably belong to the same ‘growth club’. This finding may partly explain the differences in results among previous cross-sectional studies. Most importantly, no consistent evidence is found that govern...