TESTING CONVENTIONAL AND EX ANTE PURCHASING POWER PARITY: THE CASE OF THREE CIS CURRENCIES

Transcription

1 TESTING CONVENTIONAL AND EX ANTE PURCHASING POWER PARITY: THE CASE OF THREE CIS CURRENCIES Razzaqu H.Bhai Bang Collg of Businss KIMEP Univrsiy Abai Avnu Offic #349, Dosyk Building Almay 5, Kazakhsan Tl: +7(77) Ex. 4; Fax: +7(77) M.Mujibul Haqu Bang Collg of Businss,KIMEP Univrsiy ABSTRACT This papr ss whhr convnional or x an purchasing powr pariy holds for h xchang ras of h hr CIS currncis Kazakh ng, Kyrgyz som and Russian Rubl vis-à-vis h US dollar and for h xchang ras of Kazakh ng and Kyrgyz som vis-à-vis h Russian Rubl ovr h priod 995m-m6. Rsuls obaind by mploying wo rsidualbasd coingraion ss of Engl and Grangr (987) and Phillips and Ouliaris (99) and cofficin rsricions ss basd on h Ws (988) corrcd -saisic lnd srong suppor o x an PPP agains convnional on. Ths rsuls suggs ha h ral xchang ra for h undrlying currncy combinaions is no saionary; rahr i follows a random walk. This also implis ha PPP dos no hold for h hr CIS currncis vn in h long run. Ky Words: Ex an PPP, Exchang ra, Inrnaional financial marks JEL Classificaion: E3, F3, G5 AFBE Journal Vol.6, no. 63

2 INTRODUCTION Sinc Cassl (96) prsnd i formally as an opraional hory of forign xchang, h rmndous amoun of work has appard on boh horical and mpirical aspcs of purchasing powr pariy (PPP). Th PPP hory of xchang posulas ha in counris opraing undr a sysm of flxibl xchang ras in which hr ar no such fricions as rad barrirs, ransporaion coss, and spculaors xpcaions, h nominal xchang ra bwn wo currncis adjuss fully o absorb h xcss of domsic ovr forign inflaion (masurd in rms h raio of h domsic pric indx o h forign pric indx), forcing h ral xchang ra o b consan as wll as indpndn of h raio of h domsic pric indx o h forign pric indx ovr im. In ssnc, hr ar wo main prdicions ha undrli PPP: on xplici and h ohr implici. Th xplici prdicion is ha h nominal xchang ra is drmind by h raio of h domsic pric indx o h forign pric indx, whras h implici prdicion is ha h ral xchang ra is man rvring ovr im. Dspi is wid accpanc, PPP is sill highly conrovrsial opic in h liraur on inrnaional financ and xchang ras, boh from horical and mpirical prspcivs. Mos sudis invsigaing h mpirical validiy of PPP for h currn floaing xchang ras hav documnd vidnc ha usually indicas h failur of h hory 3. On rason for h failur of PPP ovr h currn floaing xchang ras ha has bn pu forward by Bhai and Bhai (994) is ha PPP nglcs h rol of spculaors xpcaions in drmining xchang ras. I is argud ha in fficin marks for goods and capial asss, compiion among spculaors nds o sablish PPP on x an basis 4, so ha h ra of chang in h ral xchang ra, and no h ral xchang ra islf, is srially uncorrlad ovr im. This implis ha h ral xchang ra follows a random walk. This viw of PPP diffrs from h convnional viw in h xplici ramn of uncrainy. I is basd on h proposiion ha in fficin marks h n rurns o spculaors ngaging in inrmporal arbirag on goods in a forign counry is anicipad o b zro. Employing his viw of PPP, Bhai (994) and Moosa drivs a modl spcificaion implying ha in fficin marks in which spculaors ar ngagd in inrmporal arbirag on goods, h nominal xchang ra is drmind no only by currn rlaiv prics bu also by h xpcd ral xchang ra. Th objciv of his papr is o invsiga whhr convnional or x an PPP holds in hr counris Kazakhsan, Kyrgyzsan and Russia of h Commonwalh of Indpndn Sas (CIS) vis-à-vis h Unid Sa and in Kazakhsan and Kyrgyzsan vis-à-vis Russian Rpublic ovr h priod This is don by mploying h Engl-Grangr (987) and h Phillips-Ouliaris (99) procdurs for coingraion. Th rs of h papr is srucurd as follows. Scion provids a brif accoun of h hory undrlying convnional and x an PPP. Scion 3 rviws h xising vidnc on h undrlying horis of xchang ras in ransiion counris including h CIS counris, whil Scion 4 dals wih daa, mhodology and mpirical rsuls. Th final Scion concluds and dals wih policy implicaions. CONVENTIONAL AND EX ANTE PPP Convnional PPP posulas ha h ral xchang ra is qual o h nominal xchang ra adjusd by h quoin bwn domsic and forign inflaion (masurd in rms of h raio of h domsic pric indx o h forign pric indx). This is givn as follows: AFBE Journal Vol.6, no. 64

3 ( P / P ) Q = S () / whr S Q ) is h nominal (ral) xchang ra (dfind as h domsic currncy pric of a ( uni of h forign currncy) and P ( P ) is h domsic (forign) pric indx. Th main forc kping h nominal xchang undrlying quaion () in lin wih h raio of h domsic pric indx o h forign pric indx is h casual chain running from mony supply o prics (via h quaniy hory of mony) o xchang ras (via PPP). Thus convnional PPP is an xnsion of h quaniy hory of mony in an opn conomy. Taking logarihm on is boh sids and using h lowr cas lrs o rprsn h logarihmic valus of h undrlying variabls, quaion () can b rwrin as q = p + s p () Convnional PPP posis ha h nominal xchang ra in Equaion () adjuss coninuously o offs h xcss of h domsic pric indx ovr h forign pric indx, vnually forcing h ral xchang o rmain consan ovr im. If h ral xchang ra is qual o a consan valu a and flucuas randomly ra ovr im around is consan valu, a, h bhavior of h ral xchang ra can modld as follows q = a + (3) u Subsiuing Equaion (3) ino (), solving h rsuling quaion for h nominal xchang ra and hn rwriing h sam in a gnral mpirically sabl sochasic rgrssion form w obain ( p p ) w s = β + + (4) β whr β = a, w = u + v whr v is an rror rm incorporaing all ffcs on h nominal xchang ra unxplaind by currn rlaiv prics. For convnional PPP o hold prcisly wll, boh of is xplici and implici prdicions mus b suppord by h daa. For h xplici prdicion o hold h hypohsis ( β, β ) = (,) should no b rjcd. On h ohr hand, for h implici prdicion o b valid h ral xchang ra mus b saionary, i.. q = s p p ~ I() 5. + Clarly, if convnional PPP, as rprsnd by quaion (4), holds boh in h shor and long run, hn h PPP dviaions (or h ral xchang ra) should b srially uncorrlad wih a man zro ovr im. Howvr, if convnional PPP dos no hold in h shor run, hs dviaions which may prsis and cumula ar xpcd o rurn o pariy ovr im in h prsnc of such conomic forcs as inrnaional commodiy arbirag and h pric-spciflow mchanism craing a counrvailing ndncy in h sysm (Gaillio, 97; and Hodgson and Phlps, 975) 6. If ru, hn h ral xchang ra will vnually rvr o uniy, hough ovr long and variabl lag lvls. Ex an PPP diffrs from convnional PPP in is prdicion concrning h bhavior of prcnag changs in h ral xchang ra. Roll (979) dmonsrad ha h PPP dviaions ar prmann and prsisn, and dvlopd h fficin mark vrsion of PPP o show ha AFBE Journal Vol.6, no. 65

4 hs dviaions ar consisn wih maringal bhavior, a sochasic procss in which changs in ral xchang ras ar srially indpndn. Tsing convnional and fficin mark vrsions of PPP for 3 xchang ras, h found rsuls supporiv of h lar vrsion in mos cass. Ths findings wr suppord srongly by subsqun sudis conducd, inr alia, by Darby (98), Adlr and Lhman (983) and Giovanni (989) 7. An imporan assumpion undrlying x an PPP is ha conomic agns ar no crain abou fuur movmns in prics and xchang ras, and, as a rsul, hy ar concrnd abou h xpcd purchasing powr of hir rurn on domsic and forign invsmn. Thrfor, if h fuur inflaion ra is xpcd o b highr a hom han abroad, hn spculaors in h domsic counry will b moivad o convr hir currn balancs ino forign currncy in an anicipaion of gains from xpcd dprciaion of h domsic currncy. Howvr, fficincy in commodiy marks a hom and abroad will forc h n rurn anicipad by spculaors ngaging in inrmporal spculaion on goods o b zro. Unlik convnional PPP, which sipulas a rlaionship bwn h currn nominal xchang ra and rlaiv prics, x an PPP sipulas a rlaionship bwn xpcd nominal xchang ra changs and inflaion diffrnials. This is givn by s (5) + = p+ p+ whr h suprscrip indicas ha h valu of h undrlying variabl xpcd a im o prvail a im +. Assuming raional xpcaions and risk nuraliy, qualiy mus hold bwn h xpcd rurn on buying a bundl of goods in h domsic and forign marks. Th formr xpcd rurn can b proxid by xpcd domsic inflaion and h lar by h sum of xpcd forign inflaion and h xpcd chang in h nominal xchang ra. Equaion (5) can b drivd from h bhavior of spculaors in an fficin mark. Efficincy in inrnaional commodiy marks obains whn currn and fuur prics of domsic and forign goods rflc fully all availabl rlvan informaion and h xpcd rurn o spculaors ngagd in inrmporal spculaion on commodiis is qual o zro. Assuming ha hr ar no ransacion coss and ha mark agns ar crain abou domsic and forign prics, hn h rurn o spculaors ngagd in mporal spculaion on goods is givn by π + s p (6) = p whr π (rprsning h ral xchang ra) is h profi mad by spculaors by ngaging hmslvs in mporal arbirag on domsic and forign goods. On h ohr hand, h profi mad by spculaors in inrmporal arbirag on goods is givn by π (7) + = p+ + s+ p+ whr π + also rprsns h xpcd ral xchang ra. Thus, h n rurn from mporal and inrmporal spculaion on goods is givn by AFBE Journal Vol.6, no. 66 ( s s ) ( p p ) + ( p p ) π (8) + π = + + +! If marks ar fficin in Fama s (97) sns, hn currn prics mus rflc all informaion availabl o agns, so ha currn prics ar h bs forcas of fuur prics. Thus Equaion

5 (8) rducs o (5) providd ha h xpcd rurn o spculaors, π + π = υ, is complly random, displaying no parn ovr im. Bhai and Moosa (994) argu ha if h mark s xpcd ra of chang of h nominal xchang ra bwn wo currncis, domsic and forign, nds o b qual o h xpcd diffrnial in inflaion ras bwn hom and forign, hn h quilibrium nominal xchang ra will b drmind no only by currn rlaiv prics bu also by h xpcd ral xchang ra. Typically, his viw of xchang ra can b drivd by solving x an PPP, as rprsnd by Equaion (5), in lvls, and wriing h rsuling xprssion in a gnral sochasic rgrssion form as follows ( p p ) + q u s β + (9) = + β β + whr q+ = s+ p+ + p+ is h ral xchang xpcd o prvail a im + and u = υ + η. Thus, Equaion (9) implis ha ha h nominal xchang ra is drmind no only by currn rlaiv prics bu also by h xpcd ral xchang ra, indicaing ha h omission of h lar maks convnional PPP miss-spcifid. Undr h assumpion ha conomic agns ar raional and ha hy fficinly procss all availabl informaion conaind in h informaion s Ω, h ral xchang ra ralizd a im + will diffr from h xpcd ral xchang ra by a zro man, srially uncorrlad rror rm. Formally, his is givn by q ε () + = q such ha E( ε Ω ) = and E ε ε ) =. Subsiuing Equaion () ino (9), w obain + ( + + i i s ( p p ) + β q = + β + β + ω () whr q + = s+ p+ + p+ is h ral xchang ralizd a im + and ω = u β ε +. If convnional PPP holds, hn h nominal xchang ra should no b influncd by h xpcd ral xchang ra, which mans ha h rsricion β = should no b rjcd. This implis ha hr will b no rol for spculaion in PPP wih rgard o xchang ra drminaion. On h ohr hand, if h rsricion β = is rjcd significanly, hn hr will b an xplici rol for spculaion in xchang ra drminaion and as such vidnc in favour of x an PPP agains convnional on. If x an PPP holds, hn i will also b inrsing o s whhr a on-o-on proporionaliy xiss bwn h nominal xchang ra and rlaiv prics and h nominal xchang and xpcd ral xchang ra, ha is whhr or no h rsricions β = and β = ar rjcd. EXISTING EVIDENCE IN THE CIS COUNTRIES A numbr of sudis hav bn conducd on convnional PPP and x an PPP in h ransiion conomis including hos of h CIS counris. An imporan finding ha mrgs AFBE Journal Vol.6, no. 67

6 from hs sudis is ha whil x an PPP holds in h CIS counris, convnional PPP dos no. Doganlar (6) sd h validiy of convnional PPP for hr CIS counris (Azrbaijan, Kazakhsan and Kyrgyzsan) by mploying four coingraion ss: Engl-Grangr (E-G) (987) s, fully modifid OLS (FM-OLS) procdur proposd by, Phillips and Hansn (99), auorgrssiv disribud lag (ARDL) approach dvlopd by Psaran and Shin (999), and Johansn (988, 99) mulivaria coingraion chniqu. Th rsuls obaind show ha nominal xchang ras, domsic prics and forign pris ar no coingrad in all h hr CIS counris whn four diffrn yps of coingraion ss wr applid. H also sd h proposiion implid by PPP ha h ral xchang ra dos no follow a random walk. In raliy, his s amouns o sing x an PPP prsuming ha if PPP holds on h basis of xpcaions, hn h ral xchang ra should follow a random walk. Consqunly, h failur o rjc h null hypohsis ha h ral xchang ra follows a random walk implis ha x an PPP holds agains convnional PPP. Employing hr ss Kwiakowski, Phillips, Schmid and Shin (KPSS), Phillips-Prron (P-P) and ADF, Doganlar (6) obains rsuls indicaing ha h ral xchang follows a random walk in h hr CIS counris and confirming ha PPP dos no hold vn in h long run. Similar rsuls wr obaind by Korhonn and Wachl (6) who sd h dgr of xchang ra pass in h CIS counris. Failur o find ha hr is a long-run rlaionship bwn nominal xchang ras and currn rlaiv prics in hs counris (including Ukrain) and ha h ral xchang ra for h undrlying CIS currncis is saionary, hy mployd x an changs in xchang ras and prics (and hnc x an PPP) o assss h dgr of xchang ra pass-hrough and producd rsuls showing ha h dgr xchang ra pass-hrough is rasonably high in all CIS counris, xcp for Gorgia. Howvr, rsuls wr obaind somwha in conras wih hs findings by Sidris (6) and Solakoglu (6). Sidris (6) mployd h Johansn coingraion mhodology o s PPP for 7 ransiion conomis including h fiv CIS counris of Blarus, Gorgia, Moldova, Russia and Ukrain and producd rsuls which alhough did no rjc PPP in h long-run in majoriy of h cass 8, h simad cofficins of h coingraing vcors wr no consisn wih h symmry and proporionaliy hypohsis suggsd by PPP in all cass. Solakoglu (6) sd PPP for coingraion in a panl framwork for ransiion counris including h igh CIS counris of Armnia, Azrbaijan, Gorgia, Kazakhsan, Kyrgyzsan, Moldova, Russia and Ukrain and found rsuls supporiv of PPP. Solakoglu (6) also compars h convrgnc ras for lss opn and mor opn ransiion counris and finds ha mor opn ransiion conomis convrg fasr han lss opn ransiion conomis. DATA DESCRIPTION AND EMPIRICAL RESULTS Convnional PPP and x an PPP, as rprsnd by quaions (4) and (), ar sd for hr currncis of h CIS counris Kazakhsan, Kyrgyzsan and Russia vis-à-vis h US dollar and for Kazakh ng and Kyrgyz som vis-à-vis h Russian rubl. Monhly daa wr obaind from h IMF CD-ROM on boh consumr and wholsal prics and xchang ras of h hr CIS currncis agains h US dollar 9. Th sampl covrs h priod 995m-m6. s is h nd priod nominal xchang ra (currncy/dollar), p c w ( p ) is h domsic w consumr (wholsal) pric indx, p c ( p ) is h forign consumr (wholsal) pric indx c w and q + ( q + ) is h x pos valu of h ral xchang ralizd a im + basd on h consumr (wholsal) pric indx. Th mhodology mployd in sing convnional and x an PPP is coingraion analysis. Prior o sing h undrlying PPP rlaionships for coingraion, ss ar conducd o AFBE Journal Vol.6, no. 68

7 drmin if h variabls undrlying boh h rlaionships ar ingrad of h sam ordr. Tsing for a uni roo (h ordr of ingraion) in h ims sris undrling quaions (4) and () is conducd on h basis of h Dicky-Fullr (979) ADF and h Phillips-Prron (988) PP ss. Th rsuls, as shown in Tabl, ar consisn in indicaing ha all h variabls ar I() in lvls and I() in firs diffrncs. TABLE : TESTING FOR A UNIT ROOT Variabl ADF PP Lvl Firs Diffrnc Lvl Firs Diffrnc KZT/USD s w w p p c c p p w q + c q KRS/USD s w w p p c c p p w q + c q RUR/USD s c c p p c q + KZT/RUR s c c p p c q + KRS/USD s c c p p c q + Significan a h 5% lvl. Tsing convnional and x an PPP for coingraion is conducd using Engl-Grangr (987) and Phillips-Ouliaris (99) ss. Two s saisics ar usd in conjuncion ach s: CRDW and ADF wih h Engl-Grangr and Ẑ and Ẑ α wih h Phillips-Ouliaris ss. Th rsuls, as rpord in Tabl, lnd srong suppor o x an PPP rahr han convnional PPP, xcp for on xchang ra (KRS/RUR) whn consumr prics ar usd. Th xpcd ral xchang ra is highly significan in all cass, rjcing h implicaion of PPP ha h ral AFBE Journal Vol.6, no. 69

8 xchang ra is consan ovr im. Th inclusion of h xpcd ral xchang ra as an addiional xplanaory variabl in h PPP quaion rinsas h proposiion of PPP ha hr is a on-o-on corrspondnc bwn h nominal xchang and rlaiv prics. Morovr, h proposiion of x an PPP ha hr is a on-o-on corrspondnc bwn h nominal xchang ra and h xpcd ral xchang ra can b rjcd in all cass, xcp for h wo xchang ras, KZT/USD and KRS/RUR. An imporan conclusion ha mrgs from hs rsuls is ha convnional PPP is misspcifid sinc i nglcs h ffc of spculaion (as proxid by h xpcd ral xchang ra) on h currn nominal xchang ra. Ths rsuls ar highly consisn wih hos obaind by Bhai and Moosa (994) who sd x an PPP for major indusrial counris using monhly daa covring h priod 97:-993:7. TABLE : TESTING FOR COINTEGRATION β KZT/USD KRS/USD RUR/USD KZT/RUR KRS/RUR WPI CPI WPI CPI CPI CPI CPI Convnional PPP (.4) β.53 (.34).7 (.38).8 (.37). (.55).9 (.3).9 (.).63 (.77) (.3) (.66) (.9) (.6) (.4) (.43) R CRDW ADF Z τ Z µ Ex An PPP β (.73) β. (.). (.5). (.33). (.).99 (.).99 (.6). (.) β.64 (.).99 (.).99 (.5).99 (.).98 (.). (.8).95 (.7) (.) (.4) (.) (.) (.3) (.7) R CRDW ADF Z τ Z µ ( β =) ( β =) Significanc of h 5% lvl. CONCLUSION This papr has prsnd mpirical vidnc on convnional and x an PPP for fiv combinaions of h currncis of hr CIS counris: Kazakhsan, Kyrgyzsan and Russia. Rsuls basd on coingraion and cofficin rsricions ss lnd srong suppor o h x AFBE Journal Vol.6, no. 7

9 an viw of PPP agains h convnional viw. An imporan conclusion ha mrgs from hs rsuls is ha h ral xchang ra in h undrlying hr CIS counris follows a random walk. End Nos. Som conomiss rac back h origin of h PPP hory mor han wo cnuris (.g., Humphry and Klhr, 98), or vn four cnuris (.g., Brnholz, 98).. Bhai (996) and Moosa and Bhai (999) hav idnifid hr hr popular misconcpions abou h hory and mpirical sing of PPP. Th firs misconcpion is ha h Cassl s hory is inrprd in such as way as o hav no rlvanc o wha Cassl has coninuously bn adhrd o hroughou his subsqun wriings. Th scond misconcpion is ha h disincion bwn absolu and rlaiv PPP is uslss and, a bs, rdundan. Th hird misconcpion is ha sing PPP in firs diffrncs amouns o sing x an PPP, implying ha h ral xchang ra follows a random walk, and as a consqunc rsuls supporiv of firs-diffrnc PPP indicas h failur rahr han h rlvanc of PPP. 3. S, among ohrs, Frnkl (98), Taylor (988), Nachan and Chrinssanhaki (99), Crowdr (99) and Coopr (994). 4. Roll (979) drivs x an PPP by assuming fficincy in goods marks, whras Adlr and Lhman (983) by assuming fficincy in capial marks. 5. Imposing h rsricion ( β, β ) = (,) on quaion (4), and solving h rsuling xprssion for h ral xchang ra w obain s p + p = q = w. 6. Gaillio (97) invsigad 5-yar avrag of ral xchang ras a 5-yar inrvals. Bcaus an avrag ral xchang ra which was obsrvd o b uniy in on priod was followd by on blow uniy in h subsqun priod, Gaillio (97) concludd ha hr was a ndncy for PPP dviaions o rvr o h quilibrium valu of on. 7. Hakkio (986) and Abuaf and Jorion (99) wr skpical of hs findings on h wo grounds: (i) h us of h low-powr ss, and (ii) h us of a univaria rgrssion modl basd in diffrncs in h ral xchang ra, which lads o imprcis sima bcaus of cross-quaion corrlaions. 8. Th xcpions ar Blarus and Gorgia for which h null of no coingraion was no rjcd. 9. Th xcpion is Russia for which only consumr prics ar usd. REFERENCES Abuaf, N. and Jorion, P. (99), Purchasing Powr Pariy in h Long Run, Journal of Financ, Vol. 45, pp Adlr, M. and Lhman, B. (983), Dviaions from Purchasing Powr Pariy in h Long Run, Journal of Financ, Vol. 38, pp Brnholz, P. (98), Flxibl Exchang Ras in Hisorical Prspciv, Princon Sudis in Inrnaional Financ, Princon: Princon Univrsiy Prss. Bhai, R. H. (996), A Corrc Ts of Purchasing Powr Pariy: Th Cas of Pak-Rup Exchang Ras, Pakisan Dvlopmn Rviw, Vol. 35, pp AFBE Journal Vol.6, no. 7

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11 Sidris, D. (6, Purchasing Powr Pariy in Economis in Transiion: Evidnc from Cnral and Eas Europan Counris, Applid Financial Economics, 6, Solakoglu. E. G. (6), Tsing Purchasing Powr Pariy Hypohsis for Transiion Economis, Applid Financial Economics, 6, Taylor, M. P., An Empirical Examinaion of Long-run Purchasing Powr Pariy Using Co ingraion Tchniqus, Applid Economics, Vol. pp Ws, K. D. (988), Asympoic Normaliy Whn Rgrssors Hav a Uni Roo, Economrica, Vol. 56, pp AFBE Journal Vol.6, no. 73