Purchasing Power Parity and International Fisher Effect Hypothesis Test: Evidence from Vietnam and 12 Major Trading Partners (2000 – 2022)

Abstract

Amidst the expansion of the global economy and Vietnam's growing integration into the international arena, the country has formed substantial trade relations with a diverse range of nations across the globe. As a result, it is crucial to comprehend and study the dynamics of exchange rates, relying on the well-established theoretical frameworks of the Purchasing Power Parity (PPP) theory and the International Fisher Effect (IFE). Given the longstanding nature of these theories, the main purpose of this study is to assess the validity and applicability of the PPP theory and IFE in explaining the changes in exchange rates between Vietnam and its various trading partners. Employing a multiple linear regression approach, we investigated quarterly historical data comprising interest rates, inflation rates, and exchange rates of 12 trading partners, including the ASEAN-5, China, the U.S., Japan, South Korea, France, Canada, and Germany from Q1 2002 to Q4 2022. The results unequivocally show that neither the PPP theory nor the IFE can adequately explain the variations in the Vietnam Dong's exchange rate with respect to those of its trade partners, underlining the existence of significant theoretical deviations. Given these observations, policymakers and investors are strongly encouraged to adopt a holistic viewpoint, including a variety of indicators, and conducting additional research to make informed decisions that support long-term economic stability and growth.