In the long run, we're all mean reverting - Wavelet analysis on the fate of real exchange rates

Abstract: This paper analyzes to what extent PPP holds in the long run. Firstly, standard unit root tests are used to test for stationarity. These results are then compared to the ones provided by a wavelet based OLS and an approximate ML estimator. Using these to determine the integration order of an ARFIMA(p,d,q) process, the results support the PPP hypothesis and indicate that real exchange rates are mean reverting and subject to long swings. Unit root tests are therefore inept for analyzing real exchange rates.