Market efficiency, purchasing power parity, and the official and parallel markets for foreign currency in Latin America

Abstract

This paper examines the purchasing power parity (PPP) theory from a long-run perspective in the presence of a parallel or ‘black’ market for U.S. dollars in four Latin American countries, namely Argentina, Brazil, Chile, and Mexico, using monthly data for the recent float. Johansen's full information maximum likelihood multivariate cointegration technique is applied. Recent developments associated with this procedure are considered. First, a formal test developed by Johansen [Econometric Theory 8 (1992) 188, Econometric Theory 11 (1995) 25, Scand. J. Stat. 24 (1997) 433] for the presence of I(2) and I(1) components in a multivariate context is applied along with the estimation of the roots of the companion matrix for the correct determination of the cointegration rank. Second, given that two significant cointegration vectors were found for any country, structural restrictions identifying the long-run relations of interest are specified as proposed by Johansen and Juselius [J. Econometrics 63 (1994) 7] and Johansen [J. Econometrics 69 (1995) 111]. Thus, the joint structure of PPP and long-run informational market efficiency could not be rejected for all countries. Furthermore, estimation of the error correction terms shows that the black market rate adjusts to eliminate any deviation from long-run PPP. Finally, stability tests proposed by Hansen and Johansen [Hansen, H., & Johansen, S. (1993). Recursive estimation in cointegrated VAR-models. Working Paper, University of Copenhagen, Institute of Mathematical Statistics; Econometrics J. 2 (1999) 306] are applied and it is shown that the dimension of the cointegration space is sample dependent while the estimated coefficients do not exhibit instability in recursive estimations.