DP1128 A Panel Project on Purchasing Power Parity: Mean Reversion Within and Between Countries

Author(s): Jeffrey A Frankel , Andrew K Rose

Publication Date: February 1995

Keyword(s): Cross-Section , Exchange Rate , Inflation , Long-Run , Real , Time-Series , Variation

JEL(s): F30

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP1128.asp

Purchase Options: An electronic copy of this Discussion Paper is available to purchase on request for £3. To order a copy, pease email orders@cepr.org.

Previous time-series studies have shown evidence of mean-reversion in real exchange rates. Deviations from purchasing power parity (PPP) appear to have half-lives of approximately four years. The long samples required for statistical significance are unavailable for most currencies, however, and may be inappropriate because of regime changes. In this study, we re-examine deviations from PPP using a panel of 150 countries and 45 annual observations. Our panel shows strong evidence of mean-reversion that is similar to that from long time-series. PPP deviations are eroded at a rate of approximately 15% annually, i.e. their half-life is around four years. Such findings can be masked in time-series data, but are relatively easy to find in cross-sections.