Real exchange rates in Latin America: the PPP hypothesis and fractional integration

Abstract

This paper tests for PPP in a group of seventeen Latin American (LA) countries by applying fractional integration techniques to real exchange rate series. Compared to earlier studies on these economies, this approach has the advantage of allowing for non-integer values for the degree of integration, and thus for the possibility of PPP not holding continuously but as a long-run equilibrium condition. Further, breaks in the series are endogenously determined using a procedure based on the least-squares principle. This is particularly crucial in the Latin American countries, which have been affected by several exchange rate crises and policy regime changes. The results, based on different assumptions about the underlying disturbances, are in the majority of cases inconsistent with PPP, even more so when breaks are incorporated: Argentina is the only country for which clear evidence of mean reversion is found in the model including a break, albeit only in the second subsample.