A Study on the Validity of Purchasing Power Parity for Selected Islamic Countries

The aim of the paper is to examine the validity of purchasing power parity (PPP) for selected Islamic countries. Purchasing power parity argues that exchange rates are determined by the general level of prices. If the parity is valid, no intervention will be required to offset the exchange rate. Since the exchange rates are exposed to unpredictable events, financial crisis and government intervention, standard unit root tests are not capable of modelling such events adequately. Therefore, the institutions or persons responsible for economic policies are hesitant to decide whether the SGP is valid or not. Markov regime switching model has been proven to give better results in the literature than in conventional tests since the exchange rate can be analyzed at rises and falls. Using a Markov switching tests in the study, we show that purchasing power parity (PPP) hypothesis holds in Malaysia and Indonesia. On the other hand, findings do not provide evidence in favour of the PPP hypothesis in Morocco and United Arab Emirates