3/28/23, 11:55 PM RPubs - Purchasing Power Parity: A Case Study

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as a measure of persistence. It is defined, according to Rogoff (1996), as the number of periods required for a
response to a shock to a time series dissipate by half. It has been widely adopted in the context of testing
empirical validity of the the PPP: see Cheung and Lai (2000), Murray and Papell (2002), Kilian and Zha (2002),
and J. Kim (2005). It is calculated using the following formula:

log(0.5)
h = .
log(1 + λ)

Note that, in the event of unit root where λ = 0, h = ∞ indicating the property of mean-aversion. If λ < 0,
the value of h is finite and positive, indicative of mean-reversion to the PPP. The value of h can be estimated
^
using the least-squares (LS) estimator λ for λ. That is,

log(0.5)
^
h = .
^
log(1 + λ)

The formula for the half-life given above is based on the following argument. Consider a simple case of
stationary autoregressive model of order 1, which can be written as

Y t = μ + ρY t−1 + et

Equivalently, we can write

ΔY t = μ + λY t−1 + et ,

where λ ≡ ρ − 1 . It is well-know that the model can be written as a moving average model of infinite order:
see, for example, Hamilton (2020). That is,
2 3
Y t = μ + et + ρet−1 + ρ et−2 + ρ et−3 . . . .

This means that, in response to a unit shock at time t − h , the response of Yt is ρh . That is, to a unit shock
that occurred h-period ago, the expected change of Y is ρh . More formally, the value of impulse-response of Y
with respect to a unit shock h-period ago can be written as

∂ Yt ∂ Y t+h
h
≡ = ρ .
∂ et−h ∂ et

By definition, the half-life is the value of h such that

h
ρ = 0.5.

Taking the natural logarithm of both side of the above and rearrange the terms for h, we have the expression as
required, using the identity that ρ = 1 + λ : see, for details, Granger and Newbold (2014).

Empirical results
In this section, the empirical results are presented with their economic interpretations and assessment. The
results of the unit root tests are presented, followed by the results of half-life estimation with further discussions
and implications.

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3/28/23, 11:55 PM RPubs - Purchasing Power Parity: A Case Study

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