Testing purchasing power parity for Japan and the US: A structural-break approach

- We investigate both weak and strong form of PPP between Japan and US.
- We take into account possible structural breaks.
- We employ Gregory and Hansen (1996) and Hatemi (2008) cointegration methodologies.
- We find that weak form of PPP is not rejected.
- We find strong PPP rejected before subprime crisis.

In this work we empirically assess the weak and strong forms of purchasing power parity (PPP) hypothesis for the economies of Japan and US. Monthly data for the, traded-goods price indices and the JPY/USD exchange rate are employed for the, period from January 2000 to October 2012. This period includes large shocks, such as, the US subprime crisis and the 2011 Tsunami in Japan. We take into account possible, structural shifts and breaks by employing the class of Lee and Strazicich (2003, 2004) unit, root tests. Empirical analysis suggests that a break corresponding to the start of the US subprime crisis is not rejected. Furthermore, utilizing the Gregory and Hansen (1996) and, Hatemi (2008) cointegration methodologies, the weak form of PPP is not rejected. We, also test the strong PPP hypothesis by using Dynamic Ordinary Least Squares, (DOLS). The empirical evidence rejects the strong form of PPP for the period, preceding the US subprime crisis in contrast to the period after.