Purchasing Power Parity and the Real Exchange Rate in Bangladesh: A Nonlinear Analysis

The long-run purchasing power parity (PPP) hypothesis is examined using data for Bangladesh and its major trading partners - the US, Euro area, Japan and India - during the period 1994 to 2002. We apply recently developed nonlinear econometric techniques and provide strong evidence for highly nonlinear meanreversion of real bilateral Bangladesh taka exchange rates toward a stable long-run equilibrium. Our findings imply strong support for the validity of long-run PPP as well as for the theoretical models which predict nonlinear adjustment in real exchange rates.