POST BRETTON-WOODS DEVIATIONS FROM PURCHASING POWER PARITY IN G7 EXCHANGE-RATES - AN EMPIRICAL EXPLORATION

Exchange rates have deviated substantially and idiosyncratically from purchasing power parity (PPP) since the breakdown of Bretton Woods. In this paper, a model incorporating both traditional PPP and financial market variables is constructed and tested on the US dollar's six G7 e xchange rates during the floating rate era. Empirical tests show that the model's common set of variables-with consistent signs-can explain the divergent behavior of G7 exchange rates during 1973.2-90.2. Idiosy ncracies are reflected in different subsets of the model's variables e ntering significantly into each exchange rate's regression; the existe nce of stable relationships is demonstrated by the equations' co-integ ration. (JEL F3, F4). Copyright (C) 1996 Elsevier Science Ltd.