Sticky prices and deviations from the Law of One Price: Evidence from Mexican micro-price data

This paper uses a novel dataset of weekly sampled store-level prices to study the impact of sticky prices on the volatility and persistence of intranational deviations from the Law of One Price (LOP). The volatility of LOP deviations is found to be increasing both on the distance separating two locations and on the degree of price stickiness. Sticky prices are also found to be systematically related to the persistence of LOP deviations: Half-lives of LOP deviations are systematically larger for goods with stickier prices. These observations are shown to accord well with the predictions of a dynamic general equilibrium model featuring real market segmentation and Calvo pricing. I also find evidence of remarkably fast convergence to the LOP (average half-lives of LOP deviations are in the order of 3-6 weeks) and show that previously reported convergence estimates may be afflicted by a positive temporal aggregation bias.