Purchasing Power Parity in Tradable Goods
A vast body of empirical research documents the linkage between nominal exchange rates and relative prices across countries. While excellent surveys exist in the academic literature on this topic, they focus largely or entirely on broad baskets of prices and, most commonly, on the consumer price index. The present survey focuses mainly on internationally tradable goods and services, rather than broad baskets of goods and services that also include a substantial nontradable component. Speci cally, the objective of this paper is to distill the empirical literature on the properties of deviations from the law of one price applied to internationally tradable goods or sectors i. e. the proposition that price levels of similar goods, expressed in a common currency, have a tendency to equalize over time. We conclude that a careful reading of the literature suggests that this notion of PPP holds in the long run for a broad range of tradable goods and services and for a broad set of currencies. In turn, one implication is that the exchange rate risk for a long-horizon investor is relatively small.
- Lucio Sarno, Evgenia Passari