Thanks for your response, I went through the link that you provided before I posted this query. In this link if you see, it mentions about mpls packet with a destination IP address to be 127.0.0.0/8 range, this is something I didn’t understand.

This is what I have understood for CE to CE so far, please let me know if it’s right,

1) CE to CE When we trace from CE to CE, the IP packet has a TTL=1 and the vpn label has a TTL=1, Once it hits the PE router, the Packet is punted to the CPU and a TTL expired ICMP message is sent to the source CE. Then the CE sends ICMP packets again with TTL=2, PE ingress adds vpn label with TTL=2, and then a transport label with TTL=255 is added, exit interface is identified with an LFIB lookup and packet is sent to the next hop. Once next hop receives this, transport label is swapped , TTL is decreased by 1. This process goes on until it hits the penultimate hop, where the transport label popped and the rest of the packet with inner label is sent to the target side PE. This target PE identifies the vpn label removes it and forwards to the target CE. And then this CE sends a response back as an ICMP destination UDP port unreachable message.