Recursive Cointegration Analysis of Purchasing Power Parity: An Application to Asian Countries

Abstract

Previous studies have utilized conventional cointegration tests that are based on the assumption that the long-run purchasing power parity (PPP) relationship is stable over the sample period. This assumption can be misleading if there were significant economic and policy changes over the sample period. To allow for the possibility of instability in the long-run PPP relationship, we utilize recursive cointegration analysis to test for the stability of cointegrating ranks and parameters. The results indicate evidence of cointegration for Korea, Malaysia, and Singapore, and a short window for Thailand around the 1997/98 Asian crisis with no evidence of structural breaks in the cointegrating vectors. Evidence of turbulence is detected around the 1997/98 crisis, the 1985 Plaza Accord, and around 1978-1984. Longrun parameters appear to have been stable for Malaysia, the Philippines, and Singapore, whereas instable for Indonesia, Korea, and Thailand.