Non-linear adjustments to intranational PPP

Abstract

We study the intranational purchasing power parity (PPP) between 17 pairs of Canadian cities for the period 1984–2010, using multivariate tests of threshold cointegration in a threshold vector error correction model. Our results confirm the existence of cointegration with threshold symmetric and asymmetric adjustment processes toward PPP equilibrium. We also estimate the unconditional half-lives for non-linear PPP deviations to measure PPP persistence. We find that the speed of non-linear mean reversion may be faster than previously thought when allowing non-linear adjustments. In addition, we measure the absorption of shocks and suggest that different types of shocks are absorbed at different rates by different variables in the system. The evidence reveals that there are complex non-linearities in the price data and these justify the use of non-linear methods to study adjustments to intranational PPP.