Purchasing power parity and the real rand-dollar exchange rate

Abstract

This paper tests for evidence in support of the purchasing power parity (PPP) in the bilateral real exchange rate series of the South African rand against the US dollar. The importance of considering structural breaks in the PPP test is illustrated. Using standard unit root tests without considering structural breaks, the study is unable to reject the null hypothesis of a unit root in the exchange rate series. However, our additive outlier model clearly demonstrates the importance of multiple sudden structural breaks and supports the stationarity of rand’s real exchange rate against the dollar. As expected the innovative outlier model, which seeks to suggest gradual shifts, only identifies a limited number of breaks and does not support purchasing power parity.