Mini Case: Turkish Lira and the Purchasing Power ParityVeritas 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 currentlyinterested in Turkish stock markets. He thinks that Turkey will eventually be invited to negotiateits membership in the European Union. If this happens, it will boost the stock prices in Turkey.But, at the same time, he is quite concerned with the volatile exchange rates of the Turkishcurrency. He would like to understand what drives the Turkish exchange rates. Since theinflation rate is much higher in Turkey than in the U.S., he thinks that the purchasing powerparity may be holding at least to some extent. As a research assistant for him, you wereassigned to check this out. In other words, you have to study and prepare a report on thefollowing question: Does the purchasing power parity hold for the Turkish lira-U.S. dollarexchange rate?Among other things, Mr. Mobaus would like you to do the following:
1. Plot past annual exchange rate changes against the differential inflation rates betweenTurkey and the U.S. for the last 20 years.
2. Regress the annual rate of exchange rate changes on the annual inflation rate differential toestimatethe intercept and the slope coefficient, and interpret the regression results.
Data source: You may download the annual inflation rates for Turkey and the U.S., as well asthe exchange rate between the Turkish lira and US dollar from the following source:http://data.un.org. For the exchange rate, you are advised to use the variable code 186AEZF.