Purchasing Power Parity of ASEAN-5 Countries Revisited: Heterogeneity, Structural Breaks and Cross-sectional Dependence

Abstract

This paper tests the purchasing power parity (PPP) hypothesis for a collection of ASEAN-5 countries using monthly data spanning the period 1968:1–2009:11. For this purpose, a number of recently developed more powerful panel unit root tests that permit for dependence among the individual countries are employed. In addition to this, we utilize the Lagrange multiplier (LM) cointegration test developed by Westerlund, which is flexible enough to accommodate a large degree of country specific heterogeneity, cross-country dependence as well as multiple structural breaks. The main results derived from this study are: first, our findings from panel unit root tests which do not control for cross-sectional dependence appear to be clearly showing evidence against PPP. Second, the evidence from panel tests controlling for cross-sectional dependence is against PPP over the whole and 1997 pre-financial crisis periods. On the other hand, we find sufficient evidence to support PPP for ASEAN-5 countries over the post-financial crisis period. Third, in stark contrast stand the results obtained from the application of the panel cointegration test provide strong evidence of panel cointegration in whole and sub-periods, providing evidence for PPP; however, these findings have become apparent after allowing for multiple structural breaks as well as for general forms of cross-sectional dependence through bootstrap methods. We provide a detailed description of the breaks identified in the analysis, which appear to be closely associated with some macroeconomic shocks and institutional arrangements. The findings of this study offer important policy implications.