Department of Economics and Business Economics

A Resolution of the Purchasing Power Parity Puzzle: Imperfect Knowledge and Long Swings

Research output: Working paperResearch


  • Rp09 01

    Final published version, 385 KB, PDF document

  • Roman Frydman, New York University, United States
  • Michael D. Goldberg, University of New Hampshire, United States
  • Søren Johansen
  • Katarina Juselius, University of Copenhagen, Denmark
  • School of Economics and Management
Asset prices undergo long swings that revolve around benchmark
levels. In currency markets, fluctuations involve real exchange rates
that are highly persistent and that move in near-parallel fashion with
nominal rates. The inability to explain these two regularities with
one model has been called the "purchasing power parity puzzle." In
this paper, we trace the puzzle to exchange rate modelers' use of the
"Rational Expectations Hypothesis." We show that once imperfect
knowledge is recognized, a monetary model is able to account for the
puzzle, as well as other salient features of the data, including the
long-swings behavior of exchange rates.
Original languageEnglish
Place of publicationAarhus
Number of pages40
Publication statusPublished - 2009

    Research areas

  • PPP puzzle, long swings, imperfect knowledge, rational expectations hypothesis

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