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International Journal of Business and Economics

International Journal of Business and Economics
Volume 6, No. 3

December, 2007
 
A Cointegration Analysis of Purchasing Power Parity and Country Risk
 
Su-Yin Cheng
Department of Finance, National Chung Cheng University, Taiwan
 
Jong-Shin Wei
Department of International Business, Wenzao Ursuline College of Languages, Taiwan
 
Han Hou
Department of Finance, National Chung Cheng University, Taiwan
 
Abstract
This paper examines purchasing power parity (PPP) for 61 countries using the panel cointegration method developed by Westerlund (2007). After controlling for cross-sectional dependence, the results show that weak PPP is stronger for Latin American countries and for countries with moderate country risk, defined in terms of political, economic, and financial components, with direct or indirect implications for the validity of PPP. Compared with a single country characteristic that might affect PPP as suggested in the literature, country risk captures more information for explaining the validity of the PPP hypothesis.
 
Keywords:purchasing power parity, country risk, panel cointegration, cross-sectional dependence.
 
JEL Classifications:C23, F31, O57.
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