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A Markov-Switching Dickey-Fuller Model of Purchasing Power Parity

The conceptual inception of Purchasing Power Parity (PPP) dates back to XVI century Spain. Approximately five hundred years afterwards, economists are just beginning to arrive to a partial consensus in regard to this complex theory; hence giving way to what economist Kenneth Rogoff defined in his 1996 paper as the “Purchasing Power Parity Puzzle”. My project is based on a paper written by Angelos Kanas in 2005, as well as several others, in order to explore the possibility of adding on to the solution set for the PPP puzzle by means of incorporating a Markov-Switching component to the previously studied AR(k) models. The model is then tested for weak stationarity by means of the Augmented Dickey-Fuller unit root test and conclusions are derived.