The following regression analysis was conducted for the inflation rate information and exchange rate of the British pound:
$e _ { B P } = a _ { 0 } + a _ { 1 } \left( \frac { \left( 1 + I _ { U S } \right) } { \left( 1 + I _ { B } \right) } - 1 \right) + \mu$
Regression results indicate that a₀ = 0 and a₁ = 2. Therefore:

Question

The following regression analysis was conducted for the inflation rate information and exchange rate of the British pound:

e _ { B P } = a _ { 0 } + a _ { 1 } \left( \frac { \left( 1 + I _ { U S } \right) } { \left( 1 + I _ { B } \right) } - 1 \right) + \mu

Regression results indicate that a₀ = 0 and a₁ = 2. Therefore:

Quizplus · Accepted Answer

The regression coefficient for inflation rate differential is positive (a₁=2), indicating that the exchange rate of the British pound did not fully adjust to changes in inflation rates, and therefore, purchasing power parity underestimated the exchange rate change during the period under examination. This means that the actual exchange rate change was more significant than what was predicted by purchasing power parity. Therefore, the correct answer is C. Option A is incorrect because the regression results do not indicate that purchasing power parity holds. Option B and D are incorrect because the regression results do not provide information about over- or underestimation of the exchange rate change during future periods.

The Following Regression Analysis Was Conducted for the Inflation Rate eBP=a0+a1((1+IUS)(1+IB)−1)+μe _ { B P } = a _ { 0 } + a _ { 1 } \left( \frac { \left( 1 + I _ { U S } \right) } { \left( 1 + I _ { B } \right) } - 1 \right) + \mueBP​=a0​+a1​((1+IB​)(1+IUS​)​−1)+μ

The Following Regression Analysis Was Conducted for the Inflation Rate $e _ { B P } = a _ { 0 } + a _ { 1 } \left( \frac { \left( 1 + I _ { U S } \right) } { \left( 1 + I _ { B } \right) } - 1 \right) + \mu$