Testing Purchasing Power Parity

Abstract

We defined the purchasing power parity (PPP) in the scenario of Pakistan and India as a long term unit elasticity of exchange rate and compared it with relative national prices. The characteristic of finite sample are analyzed through time series regression analysis. It allows the cross sectional dependency, country heterogeneity and non-stationary disorder. Because the deviation of PPP is decrease with very slow rate, we execute the test on the data of 43 years. The past studies have showed that data was collected on the basis decades, like some of the researcher data contained on 08, 35 and 55 years. Additionally using the time series regression, this study observed the structural changes over a long term period. In this study, result identifies that the real exchange rate of India and Pakistan are not constant. The practical evidence shows that long run PPP holds for the sample countries.

Keywords: Purchasing Power Parity; Exchange rate; Time Series Regression Test; Relative National Prices