A1262
Title: Global volatility shocks and the PPP puzzle
Authors: Tales Padilha - University of Oxford (United Kingdom) [presenting]
Susana Campos Martins - University of Oxford (United Kingdom)
Abstract: Most of the discussion about the Purchasing Power Parity (PPP) Puzzle has pertained to the reversion speed of deviations from PPP. Much less attention, however, has been given to the other component of the puzzle: the high volatilities of real exchange rates. We provide a framework that is capable of explaining the econometric sources of these volatilities. First, we study the drivers of real exchange rate volatilities using a Cross-Sectionally Augmented Autoregressive Distributed Lag (CS-ARDL) panel framework and the conditional covariance matrices of the system with nominal exchange rates and price differentials. This analysis indicates that, for both emerging and developed markets, common factors are the main drivers of volatility. With this result in hand, we propose a novel econometric framework - based on the endogenous common volatility shocks model - that explains the sources of these volatilities as common second-moment shocks. This framework allows us to give structure to the origins of these high volatilities and propose an extension to study their macro-financial drivers.
