Testing for Purchasing Power Parity in Southeast Asian Currencies: Panel Data Approach

Abstract

This paper analyses purchasing power parity (PPP) for eight Southeast Asian economies using panel unit-root and cointegration tests designed for handling cross-sectional dependence. The main empirical findings are as follows. Southeast Asian real exchange rates in terms of yen are highly correlated because the nominal exchange rates are determined as arbitrage rates. The average correlations are 0.28 for first-differenced dollar-based real rates and 0.69 for first-differenced yen-based real rates. PPP is supported for yen-dominated Southeast Asian currencies by panel unit-root and cointegration tests if cross-sectional independence is assumed but is not supported if cross-sectional dependence is allowed for instead. Our simulation results suggest that the latter inference is the appropriate one for our data.

Keywords: PPP, Southeast Asian currencies, cross-sectional dependence

JEL Classification: F31