Is Purchasing Power Parity Overvalued

The purpose of this paper is to re-examine the hypothesis of long-run Purchasing Power Parity among industrial countries under the current float using the panel data approach. We propose a new finite-sample panel data unit-root test procedure that allows for a general serial correlation structure and arbitrary contemporaneous correlation in model innovations across countries. This procedure is then applied to the recently developed panel data unit-root tests of Im, Pesaran and Shin (1996) and of Maddala and Wu (1999). The test results show sufficient evidence against the unit-root null for most samples. By comparing our results with the existing ones in the literature, we found that the method of assuming a restrictive serial correlation structure tends to weaken evidence against the unit-root null.