Turkish Lira and the Purchasing Power Parity

Veritas 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 currently interested in Turkish stock markets. He thinks that Turkey will eventually be invited to negotiate its 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 Turkish currency. He would like to understand what drives the Turkish exchange rates. Since the inflation rate is much higher in Turkey than in the U.S., he thinks that the purchasing power parity may be holding at least to some extent. As a research assistant for him, you were assigned to check this out. In other words, you have to study and prepare a report on the following question:

Does the purchasing power parity hold for the Turkish lira (TRY) - U.S. dollar ($) exchange 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 between

Turkey and the U.S. for the last 20 years.

2. Regress the annual rate of exchange rate changes on the annual inflation rate differential to estimate the intercept and the slope coefficient, and interpret the regression results.

Year S(TRY/US$) Inflation rate _TK Inflation rate_US

1979 0.0000311

1980 0.0000760 110.17% 13.51%

1981 0.0001112 36.58% 10.32%

1982 0.0001626 30.84% 6.16%

1983 0.0002255 31.40% 3.21%

1984 0.0003667 48.38% 4.32%

1985 0.0005220 44.96% 3.56%

1986 0.0006745 34.62% 1.86%

1987 0.0008572 38.85% 3.74%

1988 0.0014223 73.67% 4.01%

1989 0.0021217 63.27% 4.83%

1990 0.0026086 60.31% 5.40%

1991 0.0041718 65.97% 4.23%

1992 0.0068724 70.07% 3.03%

1993 0.0109846 66.10% 2.95%

1994 0.0296087 106.26% 2.61%

1995 0.0458451 88.11% 2.81%

1996 0.0814049 80.35% 2.93%

1997 0.1518650 85.73% 2.34%

1998 0.2607243 84.64% 1.55%

1999 0.4187829 64.87% 2.19%

2000 0.6252185 54.92% 3.38%

2001 1.2255881 54.40% 2.83%

2002 1.5072264 44.96% 1.59%

2003 1.5008852 25.30% 2.27%

2004 1.4255373 10.58% 2.68%

2005 1.3435831 10.14% 3.39%

2006 1.4284534 9.60% 3.23%

2007 1.3029309 8.76% 2.85%

2008 1.3015217 10.44% 3.84%

2009 1.5499598 6.25% -0.36%

2010 1.5028486 8.57% 1.64%

2011 1.6749546 6.47% 3.16%

2012 1.7960009 8.89% 2.07%

2013 1.9037682 7.49% 1.46%

2014 2.1885424 8.85% 1.62%

2015 2.7200085 7.67% 0.12%

2016 3.0201347 7.78% 1.26%

2017 3.6481326 10.81% 10.81%