Bounds testing cointegration methods and PPP: evidence from 123 Countries

Cointegration analysis is often used in empirical studies of Purchasing Power Parity (PPP) to test whether there is a long-run relationship among countries' bilateral exchange rates and price levels. But the presence of a cointegrated relationship is not enough to support PPP, as other restrictions must be met as well. Nevertheless, even simple cointegration has been rejected for many countries in previous studies. We apply the 'bounds testing' approach of Pesaran et al. (2001), which has only seen limited use thus far, to analyse 123 countries' bilateral rates with the United States. Besides testing for cointegration, we also assess whether our long-run coefficients support the PPP hypothesis. We find that while most rates are indeed cointegrated, only a few have coefficients that meet even one of the necessary restrictions for PPP.