Purchasing Power Parity Under Different Exchange Rate Regimes

After a systematic review of Purchasing Power Parity theory and empirical tests, we use quantile autoregression technique to comprehensively examine the mean reversion properties of the RMB/USD, RMB/EURO and RMB/JPY exchange rate, and whether PPP exists, compared with traditional unit root test. In addition, we run inter-quantile differences testing to compare not only the impact of the larger and smaller differences, but also the impact of positive and negative differences in mean reversion. Then we calculate the half-life under different quantiles, to measure the speed of convergence of RER towards the long-run equilibrium level. The research period is from January1994to December2012, also divided into two periods according to different regimes, that is pegged to the dollar exchange rate system (Jan,1994-Jul,2005) and referred to a basket of currencies, managed floating exchange rate system (Aug,2005-Dec,2012).The empirical study found five findings, they are worth summarizing: Conclusion1is that PPP exists partially for RMB exchange rate under quantile unit root test, which is superior than traditional unit root test. Conclusion2is that RMB hit by a larger shock has a faster recovery speed. Conclusion3is that response of exchange rate adjustment subjected to positive and negative shocks is asymmetric. During the whole research period, RMB/USD and RMB/JPY exchange rate has faster recovery speed under negative shocks, while RMB/EURO exchange rate has faster recovery speed under positive shocks. Conclusion4is that RER adjusted by PPI is more likely to support PPP than RER adjusted by CPI. Conclusion5is that mean reversion of RMB/EURO exchange rate can be simulated well by LSTAR model, which support the asymmetric response of positive and negative shocks.