Non-linear adjustment in law of one price deviations and physical characteristics of goods

Berka, Martin (2006): Non-linear adjustment in law of one price deviations and physical characteristics of goods. Forthcoming in: Review of International Economics

Abstract

At a level of individual goods, heterogeneity of marginal transaction costs, proxied by price-to-weight ratios and stowage factors, explains a large part of the variation in thresholds of no-adjustment and conditional half-lives of law of one price deviations. Prices of heavier more voluminous) goods deviate further before becoming mean-reverting. Moreover, after becoming mean-reverting, prices of heavier goods converge more slowly. Together with measures of pricing power, market size, distance and exchange rate volatility, these factors explain up to 43% of variation in no-adjustment threshold estimates across 52 goods in US-Canada post Bretton Woods monthly CPI data and are robust in a broader 5-country dataset. They open two avenues for the importance of marginal transaction costs in accounting for real exchange rate persistence: through (a) generating persistence in individual real exchange rate components, and (b) accentuating it by the process of aggregation of heterogeneous components (”aggregation bias” of Imbs, et al. 2005).

• Item Type: MPRA Paper
• Institution: Massey University, Department of Commerce
• Language: English
• Keywords: Law of One Price Deviations; Real Exchange Rate Persistence; Non-Linearities; transaction costs; Physical Weight; Physical Volume; Threshold Autregres-sive Models
• Subjects: F - International Economics > F3 - International Finance > F36 - Financial Aspects of Economic Integration; F - International Economics > F3 - International Finance > F31 - Foreign Exchange

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