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Testing the PPP Using Unit Root Tests with Structural Breaks: Evidence from Politically Unstable Arab Countries

Zeina Al-Ahmad

,

Linda Ismaiel

Zeina Al-Ahmad 1 ,

Linda Ismaiel 1 
  1. Banking and Finance Sciences, Faculty of Economics, Tishreen University, Lattakia, Syria 1

Pages: 173-187

DOI: 10.18488/journal.62/2016.3.12/62.3.173.187

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Article History:

Received: 17 August, 2016
Revised: 28 September, 2016
Accepted: 18 October, 2016
Published: 02 November, 2016


Abstract:

This study examines the validity of the Purchasing Power Parity (PPP) in four Arab countries that recently experienced political instability, those being Syria, Egypt, Tunisia, and Bahrain. Using monthly data of the real effective exchange rates (REER) of the countries in question from 1995 to 2014, the study utilizes the ADF test along with unit root tests that account for endogenous structural breaks in the data, this includes the Zivot and Andrews one structural break test and the Lumsdaine and Papell one, two and three structural breaks tests. The findings were in favor of the PPP in Syria, Egypt and Tunisia when the Lumsdaine and Papell three structural breaks test was applied. The findings also confirm the importance of capturing the right number of the breaks in the data as tests that failed to account for structural breaks in the data were more against the PPP.  Interestingly, the findings reveal that the political instability did not cause a structural break for Syria and Egypt, which validates the criticism to the Perron test that exogenously defining structural breaks might not be appropriate.

Contribution/ Originality
This study contributes to the PPP literature as it is the first, up to our knowledge, that examines the validity of the PPP in the presence of a structural break triggered by political instability as the one experienced recently by many Arab countries.

Keywords:

Purchasing power parity (PPP), Unit root tests, Structural breaks, Lumsdaine and Papell test, Zivot and Andrews test, Political instability, Arab countries.

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Reference:

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Funding:

This study received no specific financial support.

Competing Interests:

The authors declare that they have no competing interests

Acknowledgement:

All authors contributed equally to the conception and design of the study.

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