Purchasing Power Parity
Running Head: Purchasing Power Parity
Testing the Evidence of Purchasing Power Parity and Exchange Rates
Abstract
Investment banks and foreign exchange dealers play important roles in the foreign currency markets. For purchasing power parity to hold in the long run, real exchange rates must be stationary. At the heart of the movement of foreign exchange rates is the change in a country’s balance of payments. If purchasing power parity held, then the real exchange rate would always equal one. A country 's exports would always buy exactly the same basket of goods imported from abroad. However, in practice real exchange rates exhibit both short run and long run deviations from this value.
In order to reduce currency risk, foreign exchange markets developed so people can convert their cash to different currencies as they conduct business of personal affairs. Furthermore, because payments across borders can be difficult to enforce and creditworthiness can be hard to assess, elaborate “credit procedures” have developed to facilitate international loans and financing. Commercial banks play a major role in financing and arranging foreign exchange transaction because of their expertise in financing business, checking credit, and transferring money. In addition, investment banks and foreign exchange dealers play important roles in the foreign currency markets. A number of organizations have developed to help reduce some of the risks of international trade. Regardless, there are types of risks that U.S. firms face when engaging in international trade. Furthermore, a country can run a deficit in its balance of trade and still have a strong currency given the conventional wisdom suggesting that a trade deficit should lead to a decline in a currency’s value.
When U.S. manufactures need to buy raw materials, they want to get the best possible deal. Hence they investigate several potential suppliers to determine the availability and quality of materials from
Testing the Evidence of Purchasing Power Parity and Exchange Rates
Abstract
Investment banks and foreign exchange dealers play important roles in the foreign currency markets. For purchasing power parity to hold in the long run, real exchange rates must be stationary. At the heart of the movement of foreign exchange rates is the change in a country’s balance of payments. If purchasing power parity held, then the real exchange rate would always equal one. A country 's exports would always buy exactly the same basket of goods imported from abroad. However, in practice real exchange rates exhibit both short run and long run deviations from this value.
In order to reduce currency risk, foreign exchange markets developed so people can convert their cash to different currencies as they conduct business of personal affairs. Furthermore, because payments across borders can be difficult to enforce and creditworthiness can be hard to assess, elaborate “credit procedures” have developed to facilitate international loans and financing. Commercial banks play a major role in financing and arranging foreign exchange transaction because of their expertise in financing business, checking credit, and transferring money. In addition, investment banks and foreign exchange dealers play important roles in the foreign currency markets. A number of organizations have developed to help reduce some of the risks of international trade. Regardless, there are types of risks that U.S. firms face when engaging in international trade. Furthermore, a country can run a deficit in its balance of trade and still have a strong currency given the conventional wisdom suggesting that a trade deficit should lead to a decline in a currency’s value.
When U.S. manufactures need to buy raw materials, they want to get the best possible deal. Hence they investigate several potential suppliers to determine the availability and quality of materials from
References: Biing-Shen Kuo, & Mikkola, A. (2001). How sure are we about purchasing power parity? panel evidence with the null of stationary real exchange rates. Journal of Money, Credit, and Banking, 33(3), 767-789. Retrieved from http://ezproxy.nu.edu/login?url=http://search.proquest.com/docview/195346588?accountid=25320 Dimand, R. W. (2011). Irving fisher 's the purchasing power of money. History of Economics Review, (54), 131-143. Retrieved from http://ezproxy.nu.edu/login?url=http://search.proquest.com/docview/918638796?accountid=25320 Eliteman, D. K., Stonehill, A. I., & Moffett, M. H. (2010). Multinational Business Finance (12th ed.). Massachusetts: Prentice Hall. Hendry, D.F. and Mizon, G.E. 1993, Evaluating econometric models by encompassing the VAR, in Phillips, P.C., (Ed.) Models, Methods and Applications of Econometrics, Blackwell, Basil. Hyrina, Y., & Serletis, A. (2010). Purchasing power parity over a century. Journal of Economic Studies, 37(1), 117-144. doi:http://dx.doi.org/10.1108/01443581011012289 Kidwell, D. S., Peterson, R. L., Blackwell, D. W., & Whidbee, D. A. (2003). Financial Institutions, Markets, and Money (8th ed.). Massachusetts: John Wiley & Sons Inc. Madura, J. (2003). International Financial Management (7th ed.). Ohio: Thomson.