Examining International Parity Relations between Kenya and Uganda: A Cointegrated Vector Autoregressive Approach

This paper analyses empirically the purchasing power parity, the uncovered interest parity and the real interest parity (Fisher parity) between Kenya and Uganda. The paper first tests the three parity relations using stationarity tests. Afterwards the study jointly models international parity conditions, namely PPP, RIP and UIP using a Cointegrated Vector Autoregressive approach. From the analysis of the individual parities, there is no evidence that the individual parities hold between the two countries except for RIP. On the other hand the joint VAR model establishes that the Kenya-Uganda inflation rates, interest rates, and the real exchange rate have followed a long-run equilibrium-correcting behavior. The joint Cointegrated VAR analysis reveals that all the endogenous variables explain more than 99.95% of the VAR model. This indicates a fast correction towards the long run equilibrium of the parity relations. Hence when the three parity relations are jointly modeled, it can be argued that Uganda has shown a tendency to converge to Kenya both in both nominal and real terms.