Testing for Unit Root Processes for South American Countries

Abstract

In this thesis, we aim to test the Purchasing Power Parity (PPP) hypothesis on data from ten di erent South American countries, using di erent statistical methods. We begin by testing the hypothesis using the standard linear tests augmented Dickey-Fuller and Phillips-Perron. We then continue to test in case of nonlinear processes with methods developed to increase the power of the tests; exponential smooth transition autoregressive (ESTAR) and assymetric ESTAR (AESTAR). Finally, the panel unit root Choi test is applied. We use monthly real e ective exchange rate data from 10 di erent South American countries, provided by Bruegel. Our results show that the p-values generally increase when comparing the linear Dickey-Fuller and Phillips-Perron test to the ESTAR and AESTAR tests. We reject the null hypothesis of a unit root for one country using the ESTAR test and for three countries using the AESTAR. We have ambiguous changes in the p-values when comparing the AESTAR to the ESTAR. For the Choi test, we reject the null hypothesis of a unit root for all tests but the ESTAR test. Rejecting the null hypothesis of a unit root indicates that the PPP hypothesis holds. Hence, new tests, e.g. nonlinear and panel data tests that have a higher power compared to the standard linear tests, may lead to the vindication of the PPP hypothesis.