A new solution to the purchasing power parity puzzles? Risk-aversion, exchange rate uncertainty and the law of one price: Insights from the market of online air-travel tickets
Arghyrou, Michael G
Pourpourides, Panayiotis M.
We argue that even in perfectly frictionless markets risk aversion driven by exchange rate uncertainty may cause a wedge between the domestic and foreign price of a totally homogeneous good. We test our hypothesis using a natural experiment based on a unique micro-data set from a market with minimum imperfections. The empirical findings validate our hypothesis, as accounting for exchange rate uncertainty we are able to explain a substantial proportion of deviations from the law of one price. Overall, our analysis suggests the possibility of a new solution to the purchasing power parity puzzles.
Law of one price; purchasing power parity; risk aversion; exchange rate uncertainty
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