Panel unit root and cointegration test of purchasing power parity : A study of selected African countries

The purpose of this research is to test the validity of the purchasing power parity (PPP) theory in Africa. The theory is tested through the use of panel unit root and cointegration techniques. Based on the annual data covering the period of 1980-2012, panel unit root tests of Levin, Lin and Chu (2002) and Im, Pesaran and Shin (2003) are conducted on the real exchange rate of the studied countries. The results based on the unit root tests failed to validate the theory in its strong form. However,
based on the Pedroni (1995, 1996) cointegration test of price indices and exchange rates, the results appeared remarkable in favor of long term applicability of PPP as a cointegration concept. Further test on the long run relationship revealed that domestic prices played a vital role in determining the equilibrium exchange rates (hence PPP) as far as this data is concern. As concerns major policy, based on this study, these countries could use the PPP theory to determine the equilibrium exchange rates. Even though, the strong form of PPP theory could not be attested
given the unit root approach employed, the empirical results emphasized that there is
weak evidence about the long run PPP hypothesis in these countries.