Veritas Emerging Market Fund specializes in investing in emerging stock markets of the world. Mr. Henry Mobaus, an experienced hand in international investment and your boss, is interested in Turkish stock markets. He thinks that Turkey will eventually be invited to negotiate its membership in the European Union. If this happens, it will boost stock prices in Turkey. But, at the same time, he is quite concerned with the volatile exchange rates of the Turkish currency. He would like to understand what drives Turkish exchange rates. Since the inflation rate is much higher in Turkey than in the United States, he thinks that purchasing power parity may be holding at least to some extent. He is particularly interested in the time period 1990-2003 because this is a time period in which Turkey experienced particularly high rates of inflation. As a research assistant for him, you are assigned to check this out. In other words, you have to study and prepare a report on the following question: For the time period of 1990-2003, does purchasing power parity hold for the Turkish lira-U.S. dollar exchange rate? Among other things, Mr. Mobaus would like you to do the following:

Regress the rate of exchange rate changes (percentage change in the exchange rate) on the inflation rate differential to estimate the intercept and the slope coefficient, and interpret the regression results. Interpreting the regression results means that you will have to test for statistical significance and explain how the results support or are inconsistent with PPP theory. Also, discuss the relation between the percentage change in the exchange rate and the inflation differential. For example, if there is a negative 1% inflation differential, what is the predicted percentage change in the exchange rate?

Data sources: I have downloaded the data for you. Do not download the data for 1990-2003 from the websites provided. The data you need are in an Excel file which is linked below. However, you may wish to verify that consumer price index data for OECD countries is available from the OECD, http://www.oecd.org. Also, exchange rate data is available from the website: http://pacific.commerce.ubc.ca/xr/data.html. Note that in the data provided exchange rates for the lira have not been adjusted for the redenomination of the lira in January 2005. Starting in 2005, one "new" lira = 1,000,000 "old" lira.

Mini Case Turkish Lira Data

Note: You will need to calculate both the inflation rate differential and the percentage change in the exchange rate (a.k.a. rate of exchange rate changes) from the data provided.