The Law of One Price and Its Violation: An Update on Empirical Advances

Abstract

A monetary policy aiming to achieve some desirable macroeconomic objectives may be ineffective to some degree when the highly warranted Law of One Price (LOP) operation is violated. This essentialises identification of the potential barriers to price convergence in different contexts to maximize effectiveness of the monetary policies. With this end in view this study carries out a comprehensive review of the existing literature regarding the LOP and the half-life of the price convergence. The existing empirical evidences find that the prices tend to converge in most cases, and the barriers to and the speed of the price convergence depend on the specific contexts. Moreover, by using major Australian city-level daily petrol prices (an essential commodity) over a long period (2004-2020) and by employing unit root tests, this study estimates the half-life of the petrol prices across those cities. The findings are consistent with those of some existing studies.