Essays on the Purchasing Power Parity

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Pereira, Pedro L. Valls
Marçal, Emerson Fernandes
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The purpose of this thesis is to contribute to the Purchasing Power Parity (PPP) discussions in Brazil. It is composed of 4 main chapters, aside from the chapter that outlines the objectives and main contributions of this thesis (Chapter 1), and the Bibliography. Chapter 2 offers a baseline understanding of the PPP framework, and a historical overview of the discussions regarding its validity and half-lives. Moreover, it highlights the “pitfalls” (Taylor(2001)) that preclude the reconciliation between the high volatility of nominal exchange rates and the half-lives of PPP deviations, also known as the PPP puzzle. Chapter 3 intends to present the theoretical framework that will be worked in the applied chapters of this thesis. It combines several results of previous studies regarding power and size of unit root and stationarity tests as to understand which test configurations may be best suited to be applied to real exchange rates. Also, this chapter presents the two issues that could generate bias in real exchange rate’s deviations half-lives: small sample and the heterogeneity biases. Chapters 4 and 5 are the applied chapters of this thesis. Chapter 4 has three main objectives. The first is to test stationarity on a novel dataset of Brazilian real exchange rates. The second objective is to estimate half-lives of shocks by modeling the series using two different estimators, Least Squares and Median-Unbiased, as small sample bias can be important in series that have slow mean reversion patterns. The third objective of the chapter is to compare the results in this study with other Brazilian studies such as Zini & Cati (1993) and Simoes & Marcal (2012). Chapter 5 turns itself to the issue of aggregation and heterogeneity. As a first objective, we verify the validity of the PPP when Producer Price Indices (PPI) are used to construct real exchange rates (RER), as examined by Kim (2004). As a second objective, we use the database to test if a specific kind of sectoral heterogeneity, Producer Price Index aggregation method, is indeed an important factor that increase half-lives of real exchange rates as in Pelagatti & Colombo (2015).

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