Testing Purchasing Power Parity Hypothesis for Azerbaijan

Abstract

The Purchasing Power Parity (PPP) hypothesis predicts that exchange rates are determined by the purchasing power of national currencies. This hypothesis implies equalization or co-movement of foreign and domestic good prices in long-run when prices expressed in the same currency, although there can be short-run deviations. The PPP hypothesis can be seen as international form of the law of one price. Under some assumptions, the law of one price foresees that identical goods must have the same prices in different markets. Transaction cost such as transportation, restrictions on free trade like quotas and custom tariffs, arbitrage preventing constraints can invalidate the PPP hypothesis. As well as price and exchange rate interventions, the presence of nontradable goods, the volume of initially-invested capital and differences between the goods or their weights included in the price indices of countries may cause to the PPP deviations or may cause not to guarantee the PPP hypothesis.