Elsevier

Economic Modelling

Volume 29, Issue 2, March 2012, Pages 326-332
Economic Modelling

On the application of the rank tests for nonlinear cointegration to PPP: The case of Papua New Guinea☆

https://doi.org/10.1016/j.econmod.2011.10.017Get rights and content

Abstract

Much interest has been paid recently to the nonlinear cointegrating relations existing among economic variables. Various testing procedures are already available to test for the existence of nonlinear cointegration. For example, Breitung (2001) proposes rank tests and his testing procedure has been broadly applied. In this study, we warn against a blind application of the rank cointegration tests, particularly to economic variables that evidence certain behavior. As an illustration, we employ the nominal exchange rates and relative prices of Papua New Guinea against her major trading partners with the objective of testing the validity of purchasing power parity for the country. Our simulation results also confirm our warnings. Additionally, we provide some simple solutions to the problem we encounter herein.

Research highlights

►We study possible nonlinear cointegrating relations in the context of PPP. ►We identify a possible problem of the rank tests for nonlinear cointegration. ►We suggest solutions to the rank problem we identify. ►We find little evidence for PPP in Papua New Guinea.

JEL classification

C32

Keywords

Nonlinearity
Cointegration
Rank tests
Purchasing power parity

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☆

Yoon's work was supported by the Research Program 2012 of Kookmin University in Korea. We thank an anonymous referee and Jörg Breitung for their helpful comments. Of course, all errors are our own.

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