Working Paper Series no. 338: Median-Unbiased Estimation in DF-GLS Regressions and the PPP Puzzle

Abstract

Using median-unbiased estimation based on Augmented-Dickey-Fuller (ADF) regressions, recent research has questioned the validity of Rogoff's "remarkable consensus" of 3-5 year half-lives of deviations from PPP. The confidence intervals of these half-life estimates, however, are extremely wide, with lower bounds of about one year and upper bounds of infinity. We extend median-unbiased estimation to the DF-GLS regression of Elliott, Rothenberg, and Stock (1996). We find that combining median-unbiased estimation with this regression has the potential to tighten confidence intervals for the half-lives. Using long horizon real exchange rate data, we find that the typical lower bound of the confidence intervals for median-unbiased half-lives is just under 3 years. Thus, while previous confidence intervals for median-unbiased half-lives are consistent with virtually anything, our tighter confidence intervals are inconsistent with economic models with nominal rigidities as candidates for explaining the observed behavior of real exchange rates and move us away from solving the PPP puzzle.

Claude Lopez, Christian J. Murray and David H. Papell
July 2011

Classification JEL : C22, F31

Keywords : PPP puzzle, median-unbiased, persistence