Purchasing Power Parity in Asian developing Countries: A Co-Integration Test

Abstract

In this study, we used co-integrating techniques to examine the long-term relationships among the exchange, and inflation rates on the major Asian Developing Countries. The short-term impact of these variables is also estimated by an error-correction model. Our result shows that there is a strong evidence that PPP holds as a long-run coastraint in countries at a lower stage of economic developments and characterized by underdeveloped capital market. For countries that have substantial foreign exchange speculations and capital movements, the changes of exchange rate deviate largely from PPP. The paper also showed that there is lack of evidence to support the conventional wisdom which predicts that a large share of nontradable sector, severe trade restrictions and intensified government intervention in foreign exchange markets would lead to a divergence between the exchange rate and PPP.