The classical dichotomy predicts that all of the time series variance in the aggregate real exchange rate is accounted for by non-traded goods in the CPI basket because traded goods obey the Law of One Price. In stark contrast, Engel (1999) found that traded goods had comparable volatility to...

Arghyrou, Gregoriou and Pourpourides (2009) argue that exchange rate uncertainty causes deviations from the law of one price. We test this hypothesis on aggregate data from the G7-area. We find that exchange rate uncertainty explains to a significant degree deviations from Purchasing Power...