The pound sterling and the franc Poincare in the 1920s: long-run relationships, speculation and temporal stability

This study examines the proposition that destabilizing speculation caused the overvaluation of the pound sterling in mid-1924 and the depreciation of the franc Poincare in mid-1925, by testing for the existence of long-run purchasing power parity in the 1920s for the dollar/sterling, franc/sterling and franc/dollar exchange rates. Using the Johansen-Juselius multivariate cointegration technique, evidence was found in favour of PPP in all the cases. However, using Hansen-Johansen (1993) tests for parameter constancy in cointegrated VAR models, it was found that the results for the dollar/sterling case are very fragile, and this may be interpreted as evidence that destabilizing speculation caused the overvaluation of sterling, while the results for the franc Poincare are rather robust, indicating that it was not deliberately undervalued.