Empirical test for purchasing power parity using a time-varying parameter model: Japan and Korea cases

Abstract

This study examines the validity of the Purchasing Power Parity (PPP) hypothesis for Japan and Korea by using a smooth time-varying cointegrating regression model. When we use the usual approaches, including unit root and cointegration tests, we fail to find the existence of the PPP for Japan and Korea. However, we find there is a time-varying cointegrating relationship between the logarithm of nominal exchange rates and the logarithm of the Producer Price Indices (PPI) ratio for Japan and Korea. This relationship does support the PPP theory. Moreover, we also find that the exact PPP theory holds for some periods in Japan and Korea.