The Long-Run Value of Currencies: A Big Mac Perspective
Purchasing Power Parity (PPP), the link between exchange rates and prices, is a fundamental building block of international finance, one which has been attracting increasing research interest during the past three decades. The Big Mac Index (BMI), invented by 'The Economist' magazine in 1986, has played a major role in popularising PPP and bringing its practical implications to the attention of financial markets. The aim of this paper is to derive long-run equilibrium values of currencies using the Big Mac data from 'The Economist' magazine. As there are only ten years of data available, we have to use a parsimonious approach to modelling the evolution of exchange rates. The stationarity of real exchange rates is tested using recently-developed panel unit root tests with modifications. Through Monte Carlo methods, we analyse the whole distribution of the estimated equilibrium exchange rates and derive the adjustment paths of actual rates into the future. The new approach we propose for equilibrium exchange rates seems to have a number of attractive features including its modest data requirements (Big Mac prices), the minimal economic structure on the problem and its simplicity. Interestingly, out estimate of the speed of adjustment of real exchange rates to shocks and of the equilibrium exchange rates are quite close to those of other studies using more complex methodologies.
|Date of creation:||2001|
|Date of revision:|
|Contact details of provider:|| Postal: 35 Stirling Highway, Crawley, W.A. 6009|
Phone: (08) 9380 2918
Fax: (08) 9380 1016
Web page: http://www.business.uwa.edu.au/school/disciplines/economics
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- J. E. Stiglitz, 1999. "Introduction," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 28(3), pages 249-254, November.
- Shang-Jin Wei & David C. Parsley, 1995. "Purchasing Power Disparity During the Floating Rate Period: Exchange Rate Volatility, Trade Barriers and Other Culprits," NBER Working Papers 5032, National Bureau of Economic Research, Inc.
- Matthew Higgins & Egon Zakrajsek, 1999.
"Purchasing power parity: three stakes through the heart of the unit root null,"
80, Federal Reserve Bank of New York.
- Matthew Higgins & Egon Zakrajsek, 2000. "Purchasing power parity: three stakes through the heart of the unit root null," Finance and Economics Discussion Series 2000-22, Board of Governors of the Federal Reserve System (U.S.).
- Ong, Li Lian, 1997. "Burgernomics: the economics of the Big Mac standard," Journal of International Money and Finance, Elsevier, vol. 16(6), pages 865-878, December.
- Zellner, Arnold, 1978. "Estimation of functions of population means and regression coefficients including structural coefficients : A minimum expected loss (MELO) approach," Journal of Econometrics, Elsevier, vol. 8(2), pages 127-158, October.
- Click, Reid W., 1996. "Contrarian MacParity," Economics Letters, Elsevier, vol. 53(2), pages 209-212, November.
- Phillips, Peter C B, 1977. "Approximations to Some Finite Sample Distributions Associated with a First-Order Stochastic Difference Equation," Econometrica, Econometric Society, vol. 45(2), pages 463-85, March.
- O'Connell, Paul G. J., 1998. "The overvaluation of purchasing power parity," Journal of International Economics, Elsevier, vol. 44(1), pages 1-19, February.
- Lucas, Robert E, Jr, 1973. "Some International Evidence on Output-Inflation Tradeoffs," American Economic Review, American Economic Association, vol. 63(3), pages 326-34, June.
- Lothian, James R & Taylor, Mark P, 1996. "Real Exchange Rate Behavior: The Recent Float from the Perspective of the Past Two Centuries," Journal of Political Economy, University of Chicago Press, vol. 104(3), pages 488-509, June.
- Mussa, Michael, 1986. "Nominal exchange rate regimes and the behavior of real exchange rates: Evidence and implications," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 25(1), pages 117-214, January.
- Froot, Kenneth A. & Rogoff, Kenneth, 1995.
"Perspectives on PPP and long-run real exchange rates,"
Handbook of International Economics,
in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 32, pages 1647-1688
- Ken Froot & Kenneth Rogoff, . "Perspectives on PPP and Long-Run Real Exchange Rates," Working Paper 32027, Harvard University OpenScholar.
- Kenneth A. Froot & Kenneth Rogoff, 1994. "Perspectives on PPP and Long-Run Real Exchange Rates," NBER Working Papers 4952, National Bureau of Economic Research, Inc.
- Renato Flôres & Philippe Jorion & Pierre-Yves Preumont & Ariane Szafarz, 1999.
"Multivariate Unit root Tests of the PPP Hypothesis,"
ULB Institutional Repository
2013/711, ULB -- Universite Libre de Bruxelles.
- Flores, Renato & Jorion, Philippe & Preumont, Pierre-Yves & Szafarz, Ariane, 1999. "Multivariate unit root tests of the PPP hypothesis," Journal of Empirical Finance, Elsevier, vol. 6(4), pages 335-353, October.
- Rayner, Robert K, 1993. "Testing for Serial Correlation in Regression Models with Lagged Dependent Variables," The Review of Economics and Statistics, MIT Press, vol. 75(4), pages 716-21, November.
- Frankel, Jeffrey A. & Rose, Andrew K., 1996.
"A panel project on purchasing power parity: Mean reversion within and between countries,"
Journal of International Economics,
Elsevier, vol. 40(1-2), pages 209-224, February.
- Jeffrey A. Frankel and Andrew K. Rose., 1995. "A Panel Project on Purchasing Power Parity: Mean Reversion Within and Between Countries," Center for International and Development Economics Research (CIDER) Working Papers C95-052, University of California at Berkeley.
- Jeffrey A. Frankel & Andrew K. Rose, 1995. "A Panel Project on Purchasing Power Parity: Mean Reversion Within and Between Countries," NBER Working Papers 5006, National Bureau of Economic Research, Inc.
- Frankel, Jeffrey A & Rose, Andrew K, 1995. "A Panel Project on Purchasing Power Parity: Mean Reversion Within and Between Countries," CEPR Discussion Papers 1128, C.E.P.R. Discussion Papers.
- Frankel, Jeffrey A. & Rose, Andrew K., 1995. "A Panel Project on Purchasing Power Parity: Mean Reversion Within and Between Countries," Center for International and Development Economics Research (CIDER) Working Papers 233411, University of California-Berkeley, Department of Economics.
- Bela Balassa, 1964. "The Purchasing-Power Parity Doctrine: A Reappraisal," Journal of Political Economy, University of Chicago Press, vol. 72, pages 584.
- K.W. Clements & E.A. Selvanathan & S. Selvanathan, 1996.
"Applied Demand Analysis: A survey,"
Economics Discussion / Working Papers
96-04, The University of Western Australia, Department of Economics.
- Bewley, Ronald & Fiebig, Denzil G, 1990.
"Why Are Long-run Parameter Estimates So Disparate?,"
The Review of Economics and Statistics,
MIT Press, vol. 72(2), pages 345-49, May.
- Bewley, R. & Fiebig, D.G., 1989. "Why Are Long-Run Parameter Estimates So Disparate?," Papers 89-3, New South Wales - School of Economics.
- Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
- Lo, Andrew W. & MacKinlay, A. Craig, 1989.
"The size and power of the variance ratio test in finite samples : A Monte Carlo investigation,"
Journal of Econometrics,
Elsevier, vol. 40(2), pages 203-238, February.
- Andrew W. Lo & A. Craig MacKinlay, 1988. "The Size and Power of the Variance Ratio Test in Finite Samples: A Monte Carlo Investigation," NBER Technical Working Papers 0066, National Bureau of Economic Research, Inc.
- Andrew W. Lo & Craig A. MacKinlay, . "The Size and Power of the Variance Ratio Test in Finite Samples: A Monte Carlo Investigation," Rodney L. White Center for Financial Research Working Papers 28-87, Wharton School Rodney L. White Center for Financial Research.
- Nickell, Stephen J, 1981. "Biases in Dynamic Models with Fixed Effects," Econometrica, Econometric Society, vol. 49(6), pages 1417-26, November.
- Michael R. Pakko & Patricia S. Pollard, 1996. "For here or to go? Purchasing power parity and the Big Mac," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 3-22.
- Dezhbakhsh, Hashem & Thursby, Jerry G., 1994. "Testing for autocorrelation in the presence of lagged dependent variables : A specification error approach," Journal of Econometrics, Elsevier, vol. 60(1-2), pages 251-272.
- Sawa, Takamitsu, 1978. "The exact moments of the least squares estimator for the autoregressive model," Journal of Econometrics, Elsevier, vol. 8(2), pages 159-172, October.
- Sevestre, P. & Trognon, A., 1985. "A note on autoregressive error components models," Journal of Econometrics, Elsevier, vol. 28(2), pages 231-245, May.
- Robert E. Cumby, 1996. "Forecasting Exchange Rates and Relative Prices with the Hamburger Standard: Is What You Want What You Get With McParity?," NBER Working Papers 5675, National Bureau of Economic Research, Inc.
- Annaert, Jan & De Ceuster, Marc J. K., 1997. "The Big Mac: More than a junk asset allocator?," International Review of Financial Analysis, Elsevier, vol. 6(3), pages 179-192.
- Frenkel, Jacob A, 1976. " A Monetary Approach to the Exchange Rate: Doctrinal Aspects and Empirical Evidence," Scandinavian Journal of Economics, Wiley Blackwell, vol. 78(2), pages 200-224.
- Andrew Parkes & Andreas Savvides, 1999. "Purchasing power parity in the long run and structural breaks: evidence from real sterling exchange rates," Applied Financial Economics, Taylor & Francis Journals, vol. 9(2), pages 117-127.
- John Williamson, 1994. "Estimating Equilibrium Exchange Rates," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 17, January.
- Levin, Andrew & Lin, Chien-Fu & James Chu, Chia-Shang, 2002.
"Unit root tests in panel data: asymptotic and finite-sample properties,"
Journal of Econometrics,
Elsevier, vol. 108(1), pages 1-24, May.
- Tom Doan, . "LEVINLIN: RATS procedure to perform Levin-Lin-Chu test for unit roots in panel data," Statistical Software Components RTS00242, Boston College Department of Economics.
- Papell, David H., 1997. "Searching for stationarity: Purchasing power parity under the current float," Journal of International Economics, Elsevier, vol. 43(3-4), pages 313-332, November.
- Kiviet, Jan F. & Phillips, Garry D.A., 1993. "Alternative Bias Approximations in Regressions with a Lagged-Dependent Variable," Econometric Theory, Cambridge University Press, vol. 9(01), pages 62-80, January.
- Ronald MacDonald & Peter B. Clark, 1998. "Exchange Rates and Economic Fundamentals; A Methodological Comparison of BEERs and FEERs," IMF Working Papers 98/67, International Monetary Fund.
- Asatoshi Maeshiro, 1999. "A lagged dependent variable, autocorrelated disturbances, and unit root tests - peculiar OLS bias properties - a pedagogical note," Applied Economics, Taylor & Francis Journals, vol. 31(3), pages 381-396.
When requesting a correction, please mention this item's handle: RePEc:uwa:wpaper:01-17. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Verity Chia)
If references are entirely missing, you can add them using this form.