Declaring a currency to be mispriced is fraught with uncertainties. In this paper, these uncertainties are explicitly recognised 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 purchasing power parity 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.
|Name||Economics Discussion Papers|