A Panel Project on Purchasing Power Parity: Mean Reversion Within and Between Countries
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Previous time-series studies have shown evidence of mean-reversion in real exchange rates.
Deviations from purchasing power parity (PPP) appear to have half-lives of approximately
four years. However, the long samples required for statistical significance are unavailable
for most currencies, and are potentially inappropriate because of regime changes. In this
study, we re-examine deviations from PPP using a panel of 150 countries and 45 annual post
WWII observations. Our panel shows strong evidence of mean-reversion that is similar to
that from long time-series. PPP deviations are eroded at a rate of approximately 15 percent
annually, i.e., their half-life is around four years. Such findings can be masked in timeseries
data, but are relatively easy to find in cross-sections.