This paper examines the purchasing power parity (PPP) hypothesis for the post-Bretton Woods era including the period after the introduction of the euro. The study applies a new nonlinear unit root test to the bilateral real exchange rates of both European and other industrial countries with the French franc and German mark (and the euro after 1998), as well as the US dollar as numeraire currencies. The results of the study provide stronger support for PPP than any earlier studies of bilateral PPP for industrial countries and suggest that (1) PPP tends to hold well within the European Union (EU) even before the adoption of the euro, (2) the evidence for PPP becomes more significant for both EU and non-EU countries when the sample period is extended to the euro era, and (3) convergence toward PPP between the EU countries, especially between the euro-area countries, tends to be nonlinear, while it is likely to be linear for the non-EU industrial countries.

The goal of this paper is to investigate the validity of PPP for a heterogeneous group of 12 transition countries with respect to dollar and euro. The analysis relies on monthly data frequency covering the period of 1994-2008. The first generation of panel unit root tests is based on the cross-sectional independency hypothesis. This paper applies five first generation unit root tests. The cross-sectional independency hypothesis is rather restrictive and somewhat unrealistic in the majority of macroeconomic applications of unit root tests. Thus, the second generation of panel unit root tests is characterized by the rejection of the cross-sectional independence hypothesis. Within this second generation of tests, two main approaches are distinguished. The first one relies on the factor structure approach. The second approach consists of imposing few or none restrictions on the residuals covariance matrix and has been adopted the use of nonlinear instrumental variables methods or the use of bootstrap approaches to solve the nuisance parameter problem due to cross-sectional dependency. We employ several second generation panel unit root tests in this paper to scrutinize the validity of PPP theory.

This bachelorthesis investigates whether purchasing power parity holds better among EU members than in the usual samples of major industrialized countries. European real exchange rates against the German mark / the euro are tested for unit roots using the Levin, Lin and Chu test. Results show evidence of stationary real exchange rates similar to results reported in the literature. The unit root hypothesis can be rejected at the five percent level for a panel of twelve European countries from 1979 to 2006. From 1999 to 2006, the unit root hypothesis can be rejected at the one percent level for the EU 25 and the EU 15, and at the five percent level for a panel of the ten countries joining the EU in 2004. The half-life of deviations from parity is estimated to be three and a half years from 1979 to 2006 and two and a half years from 1999 to 2006.