Uncertainty in currency mispricing

Kenneth W. Clements · Yihui Lan · Jiawei Si

8 citations0/0 files storedApplied Economics

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Monetary Policy and Economic Impact Financial Markets and Investment Strategies Global Financial Crisis and Policies

Abstract

Declaring a currency to be mispriced is fraught with uncertainties. In this article, these uncertainties are explicitly recognized in a model of pricing a homogeneous commodity around the world. This allows for a common driver of prices, due to a base-currency effect, and country-specific factors that lead to departures from absolute PPP on account of income differences, local taxes and charges, etc. This approach leads to estimates of currency mispricing whose significance can be tested in the usual way. Using Big Mac prices, we show that the approach has advantages over the popular Big Mac Index to currency valuation.

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References

1995Exchange Rate Dynamics Redux 2010Simple formulas for standard errors that cluster by both firm and time 2004The Purchasing Power Parity Debate 2003International Financial Statistics 1995Estimating equilibrium exchange rates 2008Exchange Rate Assessments: CGER Methodologies 2006On the Yuan: The Choice between Adjustment under a Fixed Exchange Rate and Adjustment under a Flexible Rate 2008Getting PPP right: Identifying mean-reverting real exchange rates in panels

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