Things to Do
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1. Plot ef,t against (IDC,t – IFC,t). Check if the plot forms a 45 degree line -i.e., the PPP line.
2. Determine PPP exchange rates. Graph PPP exchange rates along St. Based on your (visual) findings, clearly state if PPP captures the short-run and/or long-run behavior of St.
3. Using the whole sample, run a linear regression. Dependent variable: ef,t. Independent variable: (IDC,t – IFC,t). Null hypothesis to test: α=0 and β=1. (Note: you can use any software of your choice to run the regression. If you want to run regressions in Excel, you can simply google and find out how to run regressions in Excel.) Clearly state if you reject or cannot reject PPP.
4. Write a brief paragraph with your views about the PPP Model.