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Testing the Existence of Purchasing Power Parity in Bilateral Trade between Bangladesh and India


The paper uses the data of exchange rate and ratio of GDP deflators of Bangladesh and India covering the period 1971-2011 to justify the presence of Purchasing Power Parity (PPP) between the two countries. Unit roots test has been used to confirm the stationarity of the data. Cointegration test is used to verify the existence of a long-run relationship between exchange rate and the relative cost of bundles. While these two variables are not observed to be in equilibrium in the long run, Granger causality test finds no causal relationship between the two. This disequilibrium is further escalated due to the imposition of trade restrictions or other conditions affecting the bilateral trade relationship. These obstacles need to be addressed in order to ensure the stability of the exchange rate and maintain favourable trade relationship based on PPP.

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