Long-term Purchasing Power Parity Essay Example | Topics and Well Written Essays - 3750 words

Long-term Purchasing Power Parity - Essay Example The study compares the currency exchange factors between US Dollars ($) and Euro (â‚ ¬). The first part of the paper is a design of a framework for testing for the absolute PPP and relative PPP following monetary approach. The second part is a brief summary of the interest rate parity conditions and their underlying logics and implications. This displays the application of the exchange rate used in forward contracts differ from the current spot rate. The emphasis is on the reasons for difference between the forward rates and the future spot rate expected by investors.This study investigates the absolute and the relative PPP for international currencies including the US $ and the EURO in order to test the PPP hypothesis. The currencies support the PPP between the US and European Union with great emphasis considering that earlier studies refused to adopt the PPP hypothesis for the US and the EU countries (Mixon, 2005). Studies give evidence of the co-integration between the Euro and the US dollar rate as well as the prices of the two countries. The test for Long term PPP is conducted as an equilibrium connection using the multivariate co-integration method designed by Mixon.  This model allows various long-term links, short-term dynamics, and the adjustment certain regime shifts. If the short-term dynamics differ from the long-term links, the explicit measurement of the short-term dynamics is fundamental for a success in estimating the long-term relations of the time movement to the equilibrium.