Non‐linearities in international prices

Abstract

AbstractWe consider multiple sources of non‐linearity in good‐level law‐of‐one‐price deviations across the globe using a structural model that accounts for previously omitted variables and allows estimation of good‐level convergence rates both within and outside the bands of no trade. Accounting for the role of theoretically implied variables and their non‐linear interactions in the convergence process of law‐of‐one‐price deviations, we find that good‐level convergence rates are systematically faster compared with convergence estimates based on reduced‐form models. Contrary to conventional wisdom, good‐level price differentials exhibit mean‐reverting behaviour even within the bands of no trade. Moreover, mean‐reversion rates are strongly related to economic characteristics such as tradability and a good's non‐traded input content.