Analyzing aggregate real exchange rate persistence through the lens of sectoral data

• Authors: Laura Mayoral.
• BSE Working Paper: 110870 | September 15
• Keywords: persistence , imperfect competition , PPP puzzle , real exchange rates , heterogeneous dynamics , aggregation bias , nontradability , pricing-to-market
• JEL codes: E31, F31, D40
• persistence
• imperfect competition
• PPP puzzle
• real exchange rates
• heterogeneous dynamics
• aggregation bias
• nontradability
• pricing-to-market

In this paper we analyze the persistence of aggregate real exchange rates (RERs) for a group of EU-15 countries by using sectoral data. The tight relation between aggregate and sectoral persistence recently investigated by Mayoral (2008) allows us to decompose aggregate RER persistence into the persistence of its different subcomponents. We show that the distribution of sectoral persistence is highly heterogeneous and very skewed to the right, and that a limited number of sectors are responsible for the high levels of persistence observed at the aggregate level. We use quantile regression to investigate whether the traditional theories proposed to account for the slow reversion to parity (lack of arbitrage due to nontradibilities or imperfect competition and price stickiness) are able to explain the behavior of the upper quantiles of sectoral persistence. We conclude that pricing to market in the intermediate goods sector together with price stickiness have more explanatory power than variables related to the tradability of the goods or their inputs.