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The Exchange Rate in the Presence of Transaction Costs: Implications for Tests of Purchasing Power Parity
Author(s) -
SERCU PIET,
UPPAL RAMAN,
HULLE CYNTHIA
Publication year - 1995
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.1995.tb04060.x
Subject(s) - purchasing power parity , relative purchasing power parity , economics , transaction cost , exchange rate , interest rate parity , monetary economics , econometrics , parity (physics) , database transaction , value (mathematics) , financial economics , microeconomics , mathematics , statistics , physics , programming language , particle physics , computer science
ABSTRACT With transaction costs for trading goods, the nominal exchange rate moves within a band around the nominal purchasing power parity (PPP) value. We model the behavior of the band and of the exchange rate within the band. The model explains why there are below‐unity slope coefficients in regression tests of PPP, and why these increase toward unity under hyperinflation or with low‐frequency data. Our results are independent of the presence of nontraded goods in the economy.