On the Estimation of Purchasing Power Parity: The Divisia Approach

The whole idea of exchange rate determination between countries can be explained using two theories. These theories are Purchasing Power Parity (PPP) and Demand and Supply Theory (Balance of Payment Approach). Experts to assess the validity of Purchasing Power Parity have done much of the work bur to our knowledge, only a few researches worked and rested the PPP using Divisia approach. This paper examines the validity of the PPP hypothesis using the methodology of Divisia moments of price quantities. This approach experiences all currencies of SAARC and G- 7 separately in each trade block, rather than taking pairs of country under isolation from the rest of the world. The results show that the PPP is valid in the case of G-7 countries and not valid in the case of SAARC countries.