Purchasing Power Parity in Sri Lanka during the Recent Float: Some Empirical Evidence Using Recent Econometric Techniques

This paper investigates the purchasing power parity (PPP) hypothesis in Sri Lanka using exchange rates for six currencies during the recent float. Both univariate (Enders and Granger and Ng and Perron unit root tests) and multivariate techniques (asymmetric cointegration and errorcorrection models) are used in the empirical analysis. Enders and Granger unit root tests strongly support the PPP hypothesis for both CPI and WPI-based UK pound real exchange rates and weakly support the French franc real exchange rates. While results for the German mark are mixed, the real exchange rates for the Japanese yen, the US dollar and the Indian rupee provide no support for the PPP hypothesis. Ng-Perron tests provide strong support for the PPP hypothesis only for the UK pound for WPI-based real exchange rates. In the multivariate analysis, a PPP relationship is found only for the French franc and UK pound exchange rates. These results are consistent with univariate test results. It is also found that these two exchange rates have different adjustment patterns for positive and the negative gaps from the long-run PPP. However, the adjustment of the domestic and foreign price levels to positive and negative gaps from the long-run PPP is not statistically significant.