TESTING INTERNATIONAL PRICE TRANSMISSION UNDER ...

Empirical Tests for Spatial Price Analysis
time. What we argue is that the presence of border and domestic regulation
policies for the commodity considered (which makes export and domestic prices
for the European Union intrinsically different, as we will see in chapter 4), when
not adequately and explicitly modelled, increases the difficulties in comparing and
assessing the results.
3.4 Problems in empirical models relying on price data
As explained in paragraph 2.3, any study of price transmission ultimately refers
to verifying the validity of the LOP. Empirical evidence is controversial and, in
most cases, the LOP fails. This can be due to the scarce probability for its
hypothesis to hold in practice (paragraph 2.3), but this issue is also strictly
entangled to the underlying hypothesis and properties of the models used, and this
is particularly true if they rely only on price data.
Despite the use, over the past decades, of increasingly sophisticated techniques
(amongst which, the very development of cointegration models represented a
turning point), it is well recognized that none of the approaches described in this
chapter is preferable in all cases, and that inferences should not be based upon a
single test but, if possible, on a variety of inferential techniques. Models’
misspecifications and, more generally, their inherent characteristics, have indeed
been added as an explanation for not finding empirical evidence supporting the
LOP.
What is common to all the empirical approaches which have been revised is
that they basically rely on the use of price data, only, and of transport costs
(normally freight rates) when available. Most of the literature normally uses
traded prices (cost insurance freight, cif, or freight on board, fob) already
converted in US dollars. Price series are usually nominal 37 . As far as exchange
rates are concerned, they are likely to be endogenous only if highly aggregated
data are used, so it is claimed that the appropriate level of disaggregation allows
to treat them as exogenous variables (Richardson 1978; Goodwin et al. 1990;
Mohanty and Langley 2003). Vollrath and Hallahan (2006) propose a “detailed”
LOP model that explicitly accounts for changes in prices due to the exchange rate
(see paragraph 3.2.1). Nevertheless, some attempts of separating prices and
exchange rates have been criticised as too restrictive (Crouhy-Verac et al. 1982
cited Goodwin et al. 1990, p.686).
In all inferential techniques relying only on price data a critical problem is
constituted by transaction costs, which are composed by a variety of elements
which, as seen in the previous paragraph, hardly ever can be exactly addressed.
When tests rely on prices only it is just not possible to separately test the
37 Aldermann (1992), Goodwin et al. (1999) (both, for regional markets of the same country) and Thompson
et al. (2000), use real prices; Thompson and Bohl (1999), and Thompson et al. (2002a), also use deflated
prices but report no differences from the results obtained with the nominal ones.
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