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t, he used longer data sets and was successful in rejecting the null hypothesis for the Dollar/Pound exchange rate during the period 1869-1984. Also, he found the half-life for PPP deviations to be around 4.6 years. Niso Abuaf and Phillipe Jorion (1990) also rejected the random walk hypothesis by using data from 1901-1972 for eight currencies. They found half-life of disturbances from PPP of about 3.3 years. Using nearly two centuries of data for the Dollar/ Pound and Franc/ Pound, James R. Lothian and Mark P. Taylor (1996) found evidences of mean reversion in both exchange rates with half-life of 4.7 and 2.5 years correspondingly. Although these studies gathered relative success in the testing for PPP, their methodology has been criticised by others. Michael Mussa (1986) and Qian and Strauss (2001) argued that real exchange rates tend to be more volatile under floating than fixed exchange rates and analysis inclusive of periods of floating and fixed might eventually result in econometric implications.

In addition, the power of the test could be further improved through the inclusion of more countries into the analysis. Frankel and Rose (1995) found mean reversion on a cross-sectional analysis of floating exchange rate. They examined annual data from 1948-1992 for a total of 150 countries and were able to reject the random walk hypothesis using only post-1973 data. Abuaf and Jorion (1990) found similar results when they analysed 10 first-order autoregressive regressions for real dollar exchange rate using post 1973 data. On the other hand, Taylor and Sarno (1998) criticised that the researchers are wrong to conclude that all the rates are mean reverting when null hypothesis of random walk is rejected. Instead, the rejection of the null would only imply that at least one of the rates is mean reversion. Therefore, they suggested conducting an alternative hypothesis to test that least one of real exchange rate is non-mean reverting.

2.4 Structural Deviations from PPP

One of the most known theoretical framework presented to explain the deviations from PPP in the long run, is the Balassa-Samuelson model. (Balassa 1964 and Samuelson 1964). Their empirical results show that in general richer countries will have higher consumer price index (CPI) than poorer countries. They argued that wealthier countries are relatively more productive in the traded good sector than the poorer countries. As they have greater technological superiority in the traded goods, this will result in a rise in productivity which will in turn increase the level of wages for the sector. But as the price of tradable goods is restricted by the fixed exchange rate and world prices, it will not increase. Contrastingly for the non-traded sector, they will have to increase their price as they could not match the productivity increase of the tradable sector. In the end with the increase in the price of non-traded goods while constant price of tradable goods, the overall price level of the country have to increase. But if the nontradable goods sector is able to match the productivity gains of the tradable sector, the overall price level and real exchange rate will stay constant. This economic rationale can be applied to both fixed and floating exchange regimes. In hindsight, their findings and economic rationale highlighted the distinction between traded and nontraded goods and the impact on the price level and real exchange rates in the