Purchasing power parity in African countries : linear versus non-linear unit root tests

Abstract

This study investigated the validity of purchasing power parity (PPP) in 40 African countries by comparing the results of linear and non-linear unit root tests applied to the real effective exchange rates. Using a comprehensive dataset spanning from 1992 to 2024, the research addressed the “PPP puzzle” in African economies characterised by rapid growth and unique exchange rate dynamics. The study employed traditional linear tests alongside advanced non-linear tests to account for non-linearities, quantiles, and external covariates. Results indicated that linear tests identified stationarity consistent with PPP in only a limited number of countries, whereas non-linear tests, particularly the quantile non-linear unit root test with stationary covariates, detected stationarity in a significantly larger number of countries and across various quantiles. These findings suggest that advanced econometric techniques that incorporate quantiles and covariates provide a deeper understanding of exchange rate dynamics and PPP theory in African countries and offer valuable insights for policymakers, economists, and investors to better understand and forecast exchange rate behaviours in these dynamic markets.