Empirical conditional quantile test for purchasing power parity: Evidence from East Asian countries

Abstract

This paper develops empirical tests for the purchasing power parity (PPP) hypothesis for China, Japan and South Korea by using the quantile unit root and quantile cointegrating regression method. Unlike the conventional unit root and cointegration methods, we test for the validity of the PPP hypothesis at both the quantile interval and the single quantile level. While conventional nonlinear models could also capture the regime switching behaviour, the quantile approach enables us to avoid choosing the appropriate form of nonlinearity, and therefore, avoid the misspecification risk. When conventional methods are used, the PPP hypothesis is not strongly supported for all three countries. However, when the quantile-based approach is used, the PPP hypothesis holds for China at some quantile levels when producer price index (PPI) is used as price variable, and it also holds for Japan over the lower and upper quantile levels. Interestingly, the PPP hypothesis for South Korea holds over all quantile levels when the consumer price index (CPI) is used as the price variable.