Ex ante purchasing power parity: Some evidence based on vector autoregressions in the time domain

The ex ante purchasing power parity (EPPP) hypothesis maintains that the expected rate of nominal exchange rate depreciation should be equal to the expected inflation differential over the relevant period. By modelling the inflation differential and the rate of depreciation as a jointly determined process, this paper derives a test of EPPP by examining the vector autoregressive representation. We also make allowance for the possibility of conditional heteroscedasticity in the inflation and exchange rate innovations. Our empirical results tend to support the EPPP hypothesis.