Uncertainty in currency mispricing

Kenneth Clements, Yihui Lan and Jiawei Si

Applied Economics, 2018, vol. 50, issue 20, 2297-2312

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.

Date: 2018
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Working Paper: Uncertainty in Currency Mispricing (2016)
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DOI: 10.1080/00036846.2017.1394975

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