International Journal of Business and Economics Volume 7, No. 3 December, 2008

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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