Pairwise tests of purchasing power parity using aggregate and disaggregate price measures

In this paper we adopt a new approach to testing for purchasing power parity, PPP, that is robust to base country effects, cross-section dependence, and aggregation. We test for PPP applying a pairwise approach to the disaggregated data set recently analysed by Imbs, Mumtaz, Ravan and Rey (2005, QJE). We consider a variety of tests applied to all 66 possible pairs of real exchange rate among the 12 countries and estimate the proportion of the pairs that are stationary, for the aggregates and each of the 19 commodity groups. To deal with small sample problems, we use a factor augmented sieve bootstrap approach and present bootstrap pairwise estimates of the proportions that are stationary. The bootstrapped rejection frequencies at 26%-49% based on unit root tests suggest some evidence in favour of the PPP in the case of the disaggregate data as compared to 6%-14% based on aggregate price series