Nonlinearity and Long Memory Process: A Joint Hypothesis for The Purchasing Power Parity in MENA Countries

Abstract

The main objective of this paper is to test the validity of the purchasing power parity in some selected MENA countries. Earlier studies have used either nonlinear models or Long Memory (ARFIMA) process to look for the unit-root properties of the exchange rate behaviour. While the use of each technique independently can in some cases be favourable for the PPP hypothesis, it has failed in others. This is why recently the joint hypothesis of long memory and stochastic regime switching models has been developed. In fact, empirical evidence has shown that the two modelling techniques can be intimately linked. In this paper we will be using the FISTAR model proposed by van Dijk, Franses and Paap (2002) is order to test the validity of PPP. Several major findings have been raised from our study. The results are very promising. First, while we do not find evidence that all real exchange rates are characterized by non-linear behaviour, we find strong evidence of complimentary and substitutability between long memory and non-linear models. Here, we point out that the linear models in isolation are incapable to solve the PPP paradox. Moreover, a joint hypothesis that combines Long memory and nonlinear behaviour is a promising research to answer the PPP paradox in our selected MENA exchange rates.