Paul G.J. O'Connell

The overvaluation of purchasing power parity

Abstract Recent panel studies of purchasing power parity have reported strong evidence of mean-reversion in real exchange rates. However, these studies fail to control for cross-sectional dependence in the data. This failure has dramatic consequences, raising the significance level of tests with a nominal size of 5 percent to as much as 50 percent. It is shown in this paper that, controlling for cross-sectional dependence, no evidence against the random walk null can be found in panels of up to 64 real exchange rates. This finding cannot be attributed to low power, as there is ample power in panels of this size to reject the unit-root null.

The portfolio flows of international investors

This paper explores the behavior of daily, international portfolio flows into and out of 46 countries from 1994 through 1998. Our data are from State Street Bank & Trust and encompass over 3 million trades by client institutions. We find a number of interesting facts. First, we detect regional factors within the flows. Second, the flows are strongly persistent -- the persistence decays only slowly over time. Third, flows are strongly influenced by past returns, so that investor trend-following is apparent. Fourth forecasting power for future emerging market returns, but not for developed country returns. Fifth, we find the sensitivity of local stock prices to foreign inflows to be positive and determine that transitory inflows impact future returns negatively. Finally, we examine and reject that the positive covariance of returns and inflows is associated with an information disadvantage on the part of international investors.

''The bigger they are, the harder they fall'': Retail price differences across U.S. cities

This paper examines the evidence for nonlinear price behavior in retail goods prices across U.S. cities. First, a simple continuous-time model is used to explore the types of price behavior that can arise in the presence of market frictions. These frictions could be interpreted as transport costs, but we prefer a broader interpretation in which the frictions operate at the level of technology and preferences. Second, we gather price data from 24 U.S. cities on individual goods like orange juice and toothpaste. The empirical analysis reveals that price discrepancies between U.S. cities are stationary and nonlinearly mean-reverting to price parity.

Migration Under Uncertainty: “Try Your Luck” or “Wait and See”

Two types of uncertainty enter into the migration decision. First, current conditions in the destination region may not be observable. Second, the future evolution of conditions in both the origin and destination regions may be unknown. The first type of uncertainty can encourage speculative or “try your luck” migration, whereas uncertainty about the future acts in the opposite direction, deterring relocation. This paper presents a dynamic optimizing model of migration that incorporates both types of uncertainty. The model shows that in equilibrium uncertainty about the future is likely to be more important than uncertainty about present conditions in the decision to relocate.