Quantifying the uncertainty about the half-life of deviations from PPP

Abstract

We propose a Bayesian framework in which the uncertainty about the half-life of deviations from purchasing power parity can be quantified. Based on the responses to a survey study, we propose a prior probability distribution for the half-life under the recent float intended to capture widely held views among economists. We derive the posterior probability distribution of the half-life under this consensus prior and confirm the presence of substantial uncertainty about the half-life. We provide for the first time a comprehensive formal evaluation of several nonnested hypotheses of economic interest, including Rogoff's (1996) claim that the half-life is contained in the range of 3 to 5 years. We find that no hypothesis receives strong support from the data. Copyright © 2002 John Wiley & Sons, Ltd.