Vol. 2, No. 3 International Business Research 136 A FI-STAR Approach to the Purchasing Power Parity in the North African Countries Abdelhak BENAMAR Faculty of economics and management, University of Tlemcen- Algeria E-mail: benamarabdelhak@yahoo.fr Kamel AIT ZIANE Institute of economics, University of Khemis Miliana, Algeria E-mail: kaitziane@yahoo.fr Houria AMIMI Institute of economics, University of Khemis Miliana, Algeria Email: haitziane@yahoo.fr Mohamed BENBOUZIANE Faculty of economics and management, University of Tlemcen- Algeria E-mail: mbenbouziane@yahoo.fr Abstract The main objective of this paper is to test the validity of the purchasing power parity in the North African countries. Earlier studies have used either nonlinear models or Long Memory (ARFIMA) process to look for the unit-root properties of the exchange rate behaviour. While the use of each technique independently can in some cases be favourable for the PPP hypothesis, it has failed in others. This is why recently the joint hypothesis of long memory and stochastic regime switching models has been developed. In fact, empirical evidence has shown that the two modelling techniques can be intimately linked. In this paper we will be using the FISTAR model proposed by van Dijk, Franses and Paap (2002) is order to test the validity of PPP. Several major findings have been raised from our study. The results show that the joint hypothesis of long memory and nonlinearity is not accepted in all our North African exchange rates. In fact, the behaviour is shown to be nonlinear. The results also show that the purchasing power parity could not be accepted in the case of Tunisia. We found that there is no evidence of long memory in the cases of Algeria and Egypt. Moreover, the study has shown that when using ESTAR model alone, this can lead to some misinterpretation of the real exchange rate behaviour in many cases. This is why it is necessary to use the FI-STAR model which would give more information to policy makers to face exchange rate shocks, especially, when these shocks are characterised by a long memory process. Keywords: Purchasing Power Parity (PPP) -ARFIMA Models- FISTAR- Stationarity- North African countries 1. Introduction The Purchasing Power Parity (PPP) concept is one of the oldest and most controversial relationships in the theory of exchange rates. Although the term “purchasing power parity» was coined by Cassel (1918). it has a very much longer history in economics (See, Frenkel, 1978). It is also one of the most widely tested economic hypotheses. PPP is based on the law of one price (LOOP) and implies that exchange rates should equalize the national price levels of different countries in terms of a common currency. Although Long run PPP is a very simple proposition about exchange rate behaviour, it has attracted the attention of researchers for a long time. Indeed, it has been viewed as basis for international comparison of income and expenditures, an efficient arbitrage condition in goods and assets, an equilibrium condition, and a theory of exchange rate determination (Officier ,1976; Frenkel, 1978; Dornbush, 1987; Isard, 1978; Breuer, 1994; Froot and Rogoff, 1995; Taylor, 1995; Rogoff, 1996; Sarno and Taylor, 2001). Many studies in international finance have examined the validity of PPP over the long run either by testing whether nominal rates and relative prices move together in the long run or by testing whether the real exchange rate has a tendency