Testing the Validity of Purchasing Power Parity: Panel Cointegration Approaches with Big Mac Index

Abstract

Purchasing power parity (PPP) is vital for determining exchange rates. It has been evaluated in a variety of ways, but the findings have been inconsistent. Traded products have been the focus of much investigation relating to PPP. When it comes to non-traded products and services, the PPP deviation is especially noticeable. Against this background, this study examines the PPP from 1999 to 2021 across 27 economies, using the Big Mac as an example of an alternative non-traded good. The data analysis is conducted using the panel unit root and panel cointegration approaches. Both approaches confirm the validity of weak-form PPP. While the evidence for weak-form PPP is robust, it is inconclusive for strong-form PPP. The findings provide market participants in foreign exchange markets with guidance for the future movements of exchange rates when making investment decisions.

Keywords

• purchasing power parity
• Big Mac index
• panel cointegration