A variance-ratio test of ex ante purchasing power parity (EPPP): an examination of eleven pacific-basin countries

Abstract

Given the mounting evidence that there exist short-run deviations from conventional purchasing power parity (PPP), there has been much research interest in the time-series properties of those deviations. In particular, a permanent deviation from PPP is consistent with the ex ante version of PPP (EPPP), which rules out an intertemporal commodity arbitrage opportunity in a world of uncertainty. In contrast, without sacrificing the assumption of goods market efficiency, a violation of EPPP may provide evidence for the existence of a time-varying risk premium, or short-run exchange rate overshooting or undershooting.