Purchasing Power Parity Hypothesis in OIC Countries: Evidence from Panel Unit Root Tests with Heterogeneous Structural Breacks

Iurchasing power parity hypothesis is viewed as one of the central doctrines in international economics. The hypothesis states an equilibrium condition equating the nominal exchange rate between two national currencies with the relative price of an identical basket of traded goods in each country. Empirical analysis has produced mixed results in testing for the PPP. This paper analyzes the empirical validity of PPP hypothesis in OIC countries. Hence, it examines the stationarity of real exchange rate by ADF unit root test and various panel unit root tests. Using univariate ADF unit-root test on single time series and also the conventional panel unit root tests namely, Im, Pesaran, and Shin (2003), Levin, Lin & Chu (2002), and Hadri (2000), it was found that the real exchange rate of all OIC countries and also panel series of real exchange rate have unit root. But when recently developed panel LM unit root test that allow for heterogeneous level shifts, are applied, the null unit roots isn’t rejected in real exchange rates series. Our findings are generally supportive of the PPP hypothesis with the crises leading to shifts in long-run trends.