Content area
Full Text
This study examines the validity of the Purchasing Power Parity (PPP) hypothesis for Cambodia. The standard unit root tests (Augmented Dickey-Fuller and Phillips-Perron) and the panel unit root tests fail to support the PPP hypothesis for nine of Cambodia's trading partners. The unit root tests with structural break, however, support the PPP hypothesis for the bilateral real exchange rates of the euro, Indonesian rupiah, Malaysian ringgit and Singaporean dollar. This finding is found to be relevant for a 'de-dollarization' strategy in Cambodia, and in responding to the recent global financial crisis.
(ProQuest: ... denotes formulae omitted.)
INTRODUCTION
Purchasing Power Parity (PPP) is an essential hypothesis, which has received a great deal of attention by researchers in the field of open macroeconomics Its popularity is mainly due to its fundamental contribution to exchange rate determination. The PPP hypothesis is considered as the simplest framework to explain the long-run behavior of exchange rates. The hypothesis states that the nominal exchange rate between two currencies can be determined by the price differential or relative price of a basket of identical goods and services across the two corresponding countries. The fundamental idea is that the same prices are assumed for an identical basket of goods and services in different countries in a common currency. If a price differential exists, arbitrage activity will take place in an efficient market, allowing the nominal exchange rate to adjust to the differences of the prices across countries. The validity of the PPP hypothesis allows policymakers and exchange rate market participants to evaluate the position of the exchange rate, as to whether it is over-valued or under- valu ed.1 By the same token, the PPP hypothesis can be interpreted as a basic forecasting framework to analyze the future movements of exchange rates. In this context, the PPP hypothesis is practically evaluated by time- series econometric methods that examine whether the nominal exchange rate and relative prices are cointegrated or not. Another testing procedure is to examine whether the real exchange rate is mean- reverting (stationary) or not. To date, a huge amount of empirical studies is available with substantial contributions to the knowledge of PPP. Among them, Taylor and Taylor (2004) and Taylor (2006) have made available sufficient theoretical discussion and literature...