THE PURCHASING POWER PARITY HYPOTHESIS: IS THERE EVIDENCE FROM THE BILATERAL REAL EXCHANGE RATE BETWEEN MEXICO AND THE UNITED STATES OF AMERICA?

Abstract

The hypothesis that national price levels should be equal when expressed in a common currency has been widely studied. However, evidence from empirical literature is mixed on the validity of purchasing power parity (PPP) in the long run. This paper examined the long run validity of PPP using the bilateral real exchange rate between Mexico and the United States of America (USA). It tests for the relative version of the PPP hypothesis using uni-variate unit root technique. It discusses evidence in favor of PPP for the bilateral real exchange rate between Mexico and USA.It also finds a half-life of 1-2 years for the real exchange rate adjustment to its mean. Consequently, it suggests that there is mean reversion in the bilateral real exchange rate between Mexico and USA.