Nonlinearity and Persistence in PPP: Does Controlling for Nonlinearity Solve the PPP Puzzle?

We suggest half-life measures conditional on various regimes to examine persistence in the purchasing power parity (PPP) relations within nonlinear exponential smooth transition autoregressive (ESTAR) models. We use normal sampling and simulated confidence intervals for the regime-dependent half-lives. Statistical testing and simulations suggest that the regime-dependent half-lives work well in characterizing the persistence of departures from PPP in ESTAR models. The analysis reveals considerable persistence in PPP deviations and variation in persistence across currency groups and over time. Findings in the paper suggest that incorporating nonlinearities into PPP may not necessarily solve the PPP puzzle as claimed in some recent studies. Copyright © 2009 The Author. Journal compilation © 2009 Blackwell Publishing Ltd.