Law of one price

How is it possible that an identical Ford Mondeo was 40% more expensive in France than in Spain in May 1998 and 38% more expensive in the UK than in Portugal in November 1997? Such price differentials raise serious doubts about the validity of the law of one price (LOP), and should certainly not be observed in an integrated market. This paper aims to highlight the factors that might be responsible for such phenomena, thus adding to the empirical literature on purchasing power parity (PPP). The final verdict on the long-run validity of PPP is still open. There are a number of recent studies which provide support, in some cases even for LOP, but there are also dissenting findings 1 . Whatever the views on PPP in the long run, there is widespread agreement that short-run deviations are highly persistent (Rogoff, 1996). In this paper, two explanations are offered for the persistent deviations from the law of one price in the European car market: a) price-setting in imperfectly competitive markets and b) barriers to arbitrage.

The law of one price (LOOP) states that once the price of a traded good is expressed in a common currency, the good should sell for the same price in different countries. The intu- ition is that, in perfectly integrated international markets, free trade in goods will arbitrage away price differentials across countries. Traditionally, the size of observed bilateral trade flows has been used as the metric to gauge the actual degree of goods’ market integration - or its absence, the degree of market segmentation. The size of deviations from the LOOP provides an alternative measure. There are two commonly cited sources of goods market segmentation that give rise to LOOP deviations; first, the costs of international transactions or barriers to trade and, second, the prevalence of non-traded input costs of distributing and retailing traded goods in local markets. ? develop a multi-country Ricardian model to esti- mate international trade barriers, or trade costs , by using data on observed bilateral trade volumes. ? use estimates of trade costs to explain the observed inverse relationship between trade to GDP ratio and size of a country. This paper explores whether a multi-country Ricardian model, in which bilateral trade costs and local costs of distribution are carefully calibrated, can quantitatively account for the distribution of observed, good by good LOOP deviations.

A general consensus rejects effective commodity arbitrage and the law of one price. But this consensus is mistaken because it is based on research using retail prices where price differentials do not represent risk-free profits. Using commodity auction prices, a few articles support effective arbitrage and the LOP. Using longer intervals and a wider variety of commodities than ever before, this paper provides even stronger support for effective commodity arbitrage and the Law of One Price. In addition, for the first time, it uses commodity auction prices rather than retail prices to look for border effects and rejects them.

Physical characteristics of goods, through their importance in the marginal transaction costs, ex- plain a large part of the threshold non-linearity and conditional persistence of law-of-one-price deviations. Visible at a sufficiently detailed level of disaggregation, this mechanism creates het- erogeneity at higher levels of aggregation such as the sectoral real exchange rates. Using two post-Bretton Woods monthly datasets, a detailed US-Canadian series covering 52 products and product groups and a less detailed five-country series spanning 36 product groups, it is found that heavier goods (relative to their price) see their price differences diverge further before becom- ing mean reverting (transport costs are higher for those goods because they are more difficult to move). Furthermore, after becoming mean reverting, price differences for heavier or more volu- minous goods converge more slowly, possibly due to choice of slower mode of transport for goods with larger average price differences. Both mechanisms increase the unconditional persistence of the price differences of products with higher marginal transaction costs.

This paper has examined the degree of spatial market integration in the regional pulses markets of Pakistan using co-integration analysis and monthly wholesale price data from January, 1991 to September 2010. The results indicated that theses pulses markets are highly co-integrated and converge to long-run equilibrium in the sense that Pakistan gram, masoor and mash market system is stationary in four, three, four directions and non- stationary in three, two and two directions respectively. It means that prices in pulses markets are fully co-integrated as law of one price (LOP) holds. The study confirmed that market price linkages and the interrelationship among the spatial markets are important in economics analysis. Inter-market price linkages and speed of adjustment to shocks show that transportation costs have significant impact in determining the degree of market integration. Pulses markets in Pakistan are quite competitive and provide little justification for the government intervention designed to improve competitiveness or to enhance market efficiency. The results of the study reveals that certain market are not well integrated with each other, and order to achieve the goal of integration government should promote information and develop communication with in the markets. To enhance integration among the markets, infrastructure facilities should be provided by the government to targeted markets.

One of the most enduring puzzles in international macroeconomics, observed since the begin- ning of the post-Bretton Woods era, is that deviations from the Law of One Price (LOP) and its generalization, Purchasing Power Parity (PPP), are not only large but also highly volatile and persistent. Rogo¤ (1996) refers to the juxtaposition of these observations and the pre- dictions of structural models as the PPP puzzle. Traditionally, the attempts to address this puzzle have been based on the distinction between tradable and non-tradable goods. How- ever, since the in‡uential work by Engel (1999), most studies have shed light on the LOP deviations of tradable goods as the empirically relevant foundation of the current theoretical approaches. 1 Two main branches of the literature explore the LOP deviations of tradable

It might be asked why there are so many profitable disequilibria in these two developed markets. The possible explanation is the non-overlapping trading time. However, when the price disparity becomes greater, the large price difference gap would be arbitraged away immediately. Although the overnight risk makes the arbitrage difficult, the empirical results in this study show the monthly return ranging from 0.5 per cent to 3.8 per cent could be obtained for this simple strategy when transaction costs are considered. This evidence could be taken as possibly arising from data deficiency or method deficiency or that it is simply that these 14 stock prices are inefficiently priced across borders. Either way, the law of one price appears to be violated in the trades of these otherwise very liquid and visible Chinese shares, although in exchange rate studies, there is more evidence of arbitrage-free trades in major currencies.

“Well, you know, it is quite easy. A famous economic theory claims that when you look at the same basket of goods in two different countries, say, in Switzerland and the US, the values of both baskets should theoretically be the same because we assume that in two complete markets the exchange rate will move toward an equilibrium rate that equalizes the value of both baskets of goods in the long run. That’s known as the Law of One Price.”

The law of one price (LOOP) states that once the price of a traded good is expressed in a common currency, the good should sell for the same price in different countries. The intu- ition is that, in perfectly integrated international markets, free trade in goods will arbitrage away price differentials across countries. Traditionally, the size of observed bilateral trade flows has been used as the metric to gauge the actual degree of goods’ market integration - or its absence, the degree of market segmentation. The size of deviations from the LOOP provides an alternative measure. There are two commonly cited sources of goods market segmentation that give rise to LOOP deviations; first, the costs of international transactions or barriers to trade and, second, the prevalence of non-traded input costs of distributing and retailing traded goods in local markets. Eaton and Kortum (2002) develop a multi-country Ricardian model to estimate international trade barriers, or trade costs , by using data on observed bilateral trade volumes. Alvarez and Lucas (2007) use estimates of trade costs to explain the observed inverse relationship between trade to GDP ratio and size of a country. This paper explores whether a multi-country Ricardian model, in which bilateral trade costs and local costs of distribution are carefully calibrated, can quantitatively account for the distribution of observed, good by good LOOP deviations.

price shocks, segmented markets, sticky nominal prices and transportation costs. To assess the importance of some of these factors, a strand of literature examines the behavior of prices across cities within a country or a region. For instance, Parsley and Wei (1996) use absolute level of prices collected from several US cities and find that the convergence rate is much faster (half-lives estimated to be around four to five quarters) than that obtained from international data. Engel and Rogers (2001) examine the proportional law of one price across cities in the US and conclude that both transportation costs and sticky nominal prices explain the deviation of prices from the equilibrium. Ceccheti et al. (2002) estimate the half-life of convergence around nine years and rationalize slow convergence referring to the presence of transportation costs, differential speeds of adjustments to small and large shocks and the inclusion of traded goods prices. More recently, Goldberg and Verboven (2005) find strong evidence of convergence towards LOP using a panel data set of car prices for the case of European market integration. Crucini and Shintani (2008) using a micro-panel of goods prices collected from major cities in 63 countries and 13 major US cities present evidence that the average half-life of deviations from the LOP is about one year. Crucini et al. (2010) focus on data from cities in Japan and show that price stickiness and distance play an important role to explain the deviations from the LOP. Yazgan and Yilmazkuday (2011) reconsider price-level convergence investigating 48 final goods and service prices obtained for 52 U.S. cities. They report quicker convergence than those of previous studies.

One of the simplest and most intuitive market efficiency arguments with regard to price dynamics is incorporated into the purchasing power parity (PPP) and the law of one price (LOP). In simple words they state that the price levels (in the PPP case) or individual product prices (in the LOP case) should move together. In this paper we will be concerned specifically with the LOP. This avoids some complications related to the aggregation problems that can arise in a PPP context as well as the presence of non-tradable goods. Additionally, the validity of the LOP is essentially a necessary requirement for the PPP to hold.

Epstein sees nothing objectionable about arbitrary wage controls. Levine, recognizing the existence of this power, wishes for it to be used only to nullify unconscionable contracts, not to arbitrarily regulate wages as Epstein wants. But we are given no assurance that the Jewish community will always heed Levine rather than Epstein in its exercise of its absolute power. Thus, Levine recognizes that the power to control wages control is harmful and dangerous unless used only to nullify unconscionable contracts, but he recognizes no institutional safeguards against the abuse of democratic power to control all wages whatsoever. He endorses the community's unlimited power to control wages, naively trusting that this power will not be used inconsistently with the counself of academic economists. But a robust political system cannot trust in blind faith that the right people will be in power. Robust political economy means ensuring tolerably good results even under adverse, sub-optimal conditions (Pennington 2011). An unconstrained democratic power to impose wage and price-controls fails to satisfy this criterion. Perhaps a corollary of Murphy's Law is in order: if power – even democratic power – can be abused, it will be.

of five Justices, ‘the holding of the Court may be viewed as that position taken by those Members who concurred in the judgments on the narrowest grounds’”) (quoting Gregg v. Georgia, 428 U.S. 153, 169 n.15 (1976)). In Fernandes v. Costa Bros. Masonry, Inc., the First Circuit stated, “when the Supreme Court rules by means of a plurality opinion (as was true in Price Waterhouse), inferior courts should give effect to the narrowest ground upon which a majority of the Justices supporting the judgment would agree. The O’Connor concurrence fits this profile.” 199 F.3d 572, 580 (1st Cir. 1999) (citation omitted), overruled in part by Desert Palace, Inc. v. Costa, 123 S. Ct. 2148 (2003). Other courts, however, have disagreed with the premise that Justice O’Connor’s concurring opinion established the rule of Price Waterhouse. In Thomas v. NFL Players Association, the D.C. Circuit noted that “Justice O’Connor’s concurrence was one of six votes supporting the Court’s judgment (four Justices comprised the plurality, and Justice White filed a separate concurrence), so that it is far from clear that Justice O’Connor’s opinion, in which no other Justice joined, should be taken as establishing binding precedent.” 131 F.3d 198, 203 (D.C. Cir. 1997), vacated in part, 1998 WL 1988451 (D.C. Cir. Feb. 25, 1998); see also Tyler v. Bethlehem Steel Corp., 958 F.2d 1176, 1182-83 (2d Cir. 1992) (acknowledging that the narrowest ground support- ing a plurality opinion establishes the law, but concluding that no other Justice concurred with Justice O’Connor’s view and therefore that her direct-evidence position does not es- tablish the Court’s holding).

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All the previous studies use a TAR model to analyze the validity of the LOOP. As noted by Taylor, Peel and Sarno (2001) and Taylor and Taylor (2004), this model is very appealing in the context of individual goods but it is clear that for the aggregate real exchange rate it may be inappropriate. Transaction costs are likely to di¤er across sectors and consequently the speed of arbitrage may di¤er across goods. One could think that the aggregate real exchange rate is made up of goods prices with di¤erent implied thresholds. Some of these thresholds may be small and others will be larger. This means that as the real exchange rate moves away from equilibrium, more thresholds are crossed and thus the arbitrage forces become more powerful. Hence, one could expect that adjustment of the aggregate real exchange rate would be smooth rather than discrete and that the speed of adjustment would increase with the size of the deviation from equilibrium. 8

Regional market integration in many agricultural commodities has been extensively studied for the insight, it provides in to the functioning of such markets; such studies provide valuable information about the dynamics of market adjustment, and whether there exist market imperfection, which may justify government intervention. This study used the monthly wholesale price (Rs. /40 kg) data from January 1991 to December 2006 of gram, in Logarithmic form and empirically estimated the degree of integration in gram markets of Pakistan using co- integrations analysis. Co-integration results show that all gram markets are highly Co-integrated in the Long run. The high degree of market integration observed in this case is consistent with the view that Pakistan’s gram markets are quite competitive and provide little justification for extensive and costly government intervention designed to improve competitiveness to enhance

Over the years there has been considerable interest in and debate about the validity of the Law of One Price (LOP) as it pertains to markets for tradeable goods. On one hand, economists take it as being nearly axiomatic that freely functioning markets for traded, homogeneous products should ensure that prices are efficiently linked across regional markets, the implication being that no persistent opportunities for spatial arbitrage profits exist. This general concept is so fundamental that it often serves as an untested assumption that forms the starting point in models of exchange rate determination and regional trade. In spite of the prominent role played by the LOP in trade research, a number of qualifications to this general relationship exist. In particular, the strength of spatial linkages among commodity markets typically depends on the availability of reasonably accurate market information and the lack of significant impediments to spatial trade. Linkages that involve national borders also raise a number of issues pertaining to exchange rate pass– through and international trade policies. It is therefore common to examine commodities whose prices are denominated in a common currency, such as is the case with regional trade within national borders. An entire literature devoted to considerations of spatial market linkages within a country—the case of spatial market integration—has parallelled the Law of One Price studies. 1

This paper introduces the application of real estate pricing DP DEA - Double Perspective Data - Envelopment Analysis to solve the LOOP (Law of One Price) arbitrage. A general equilibrium model of real estate values was developed to analyze price variation over digital map, and applied to the urban area of the city of Joinville. The power of real estate locational value assessment using DP-DEA is then compared with the usual MRA - Multiple Regression Analysis using a real case of land data. All computational generated results and data were subsequently geocoded on a GIS - Geo- graphic Information System. The computational generated Price line Map is easily visualized in a real estate value chart that can enhance accuracy when compared to a conventional methodology, also a tool for immediate updates and testing the effects of new developments over urban areas.

The results of this decomposition are presented in Figure 3. The figure shows the fraction of the real exchange rate’s variability that can be accounted for by the variability of deviations in the law of one price in imports. International differences in the price of imports relative to other goods account for the rest. 22 The share accounted for by law of one price deviations is shown for all of the horizons that the data allow. The share is highest, but still very low in comparison with final goods, for the first few quarters; it then falls even further and remains even lower for most horizons. 23 Specifically, at horizons of only a few quarters, changes in the deviation from the law of one price in imports account for less than forty percent of the changes in the real exchange rate. As the horizon lengthens, deviations from the law of one price in imports generally account for less than twenty percent of the overall variation in the real exchange rate. We also decomposed the real exchange rate using Japanese and U.S. import price data from the OECD for the period 1975-2003; and, we find similar results: deviations from the law of one price again account for less than twenty percent at most horizons. We are grateful to Jos´e Campa and Linda Goldberg, for providing us with these data, which are used in Campa and Goldberg (2005). Correspondingly, at these horizons, roughly eighty percent of the variation instead can be accounted for by differences in the two countries’ internal prices of imports relative to other goods. That is, the preponderance of real exchange rate movements can be explained by changes in domestic relative prices, the second term, not by international deviations from the law of one price, the first term.

the index increases as the domestic prices of traded goods rise with the devaluation of the peso. Given our assumptions that the law of one price holds for each traded good N+1… T prior to devaluation and only Mexican prices adjust, the percentage increase of the third term is the same as the percentage devaluation after restoration of the law of one price. Notice that the price index in Mexico jumps with devaluation. 5 How the prices of nontraded goods, captured in the second term of the index, adjust is more complicated since it will depend on how traded and nontraded are related in the consumer’s market basket. It is