DP5237 'Aggregation Bias' DOES Explain the PPP Puzzle

Author(s): Jean Imbs, Haroon Mumtaz, Morten O Ravn, Hélène Rey
Publication Date: September 2005
Keyword(s): goods market integration, heterogenous dynamics, relative prices
JEL(s): C23, F15, F31
Programme Areas: International Macroeconomics, International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=5237

This article summarizes our views on the role of an 'aggregation bias' in explaining the PPP Puzzle, in response to the several papers recently written in reaction to our initial contribution. We discuss in particular the criticisms of Imbs, Mumtaz, Ravn and Rey (2002) presented in Chen and Engel (2005). We show that their contentions are based on: (i) analytical counter-examples which are not empirically relevant; (ii) simulation results minimizing the extent of 'aggregation bias'; (iii) unfounded claims on the impact of measurement errors on our results; and (iv) problematic implementation of small-sample bias corrections. We conclude, as in our original paper, that 'aggregation bias' goes a long way towards explaining the PPP puzzle.