Currency Fair Value Models

Abstract

This chapter reviews models that are used by policymakers and international investors in order to assess exchange rate misalignments from their fair value. It provides an exposition of a number of fair value and equilibrium exchange rate models that are widely used in practice. The chapter discusses the theories of long-term deviations from purchasing-power parity (PPP) and their practical application to fair value modeling. It talks about the behavioral equilibrium exchange rate (BEER) and the underlying balance (UB) models. The basic characteristics of fair value models are analyzed with a particular focus on how implicit or explicit design choices typically affect the results, the robustness and the general usability of these models. The chapter explains the sensitivity of UB models with regard to variations in import and export elasticities. Finally, it explains how the treatment of the external balance in different models appears responsible for discrepancies between estimation results. Controlled Vocabulary Terms behavioral equilibrium exchange rate; currency fair value models; equilibrium real exchange rate (ERER) model; natural real exchange rate (NATREX); permanent equilibrium exchange rate model; underlying balance approach

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