(ii)ppp using bigmac
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7/31/2019 (II)PPP Using BigMac
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Empirical Analysis ofPurchasing Power Parity
BigMac Index vs Exchange Rate
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1. Purchasing Power Parity
Compare the price of BigMac in twodiferent countries, denominated intwo different currencies
3,000 in Korea $ 2.5 in US
Exchange rates are determined to reflect purchasing
power between two countries
In the hypothetical example, solve \3,000=$2.5 to get
$1=\1,200, which is the won-dollar exchange rate as
determined by the BigMac index
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2. Purchasing Powerand Exchange Rates
To compare purchasing power across countries,
choose a homogenous product, like BigMac or Coca
Cola, and compare prices denominated in local
currencies.
Hypothesis to be tested: Exchange rates are
determined by the BigMac index (or Coca Cola Index).
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For each country, its BigMac index is the price,
denominated in local curency, of $1 value of BigMac.
The Economist compiles the BigMac index since 1986
Compare BigMac index with the actual exchange rates
3. Big Mac Index
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4. Data
Download the data on the BigMac
Indices and the exchange rates from
The Economist Website
http://www.economist.com
Note: Click on BigMac Index located on the left-middle of the
HomePage. Then, you can obtain BigMac indices little bit
outdated. If you are really serious about this kind of
research, you can subscribe to the current ones.
http://www.economist.com/http://www.economist.com/http://www.economist.com/ -
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5. Model I
Simple Linear Regresion
Test whether = 0 and = 1
(Exchange Rate) = + (BigMac) +
http://ezstat.co.kr/real_life_sample/%EA%B5%AC%EB%A7%A4%EB%A0%A5%ED%8F%89%EA%B0%80%EC%84%A4/BigMac%EC%A7%80%EC%88%98%20%ED%9A%8C%EA%B7%80%EB%B6%84%EC%84%9D%20%EC%9B%90%EC%9E%90%EB%A3%8C.xlshttp://ezstat.co.kr/real_life_sample/%EA%B5%AC%EB%A7%A4%EB%A0%A5%ED%8F%89%EA%B0%80%EC%84%A4/BigMac%EC%A7%80%EC%88%98%20%ED%9A%8C%EA%B7%80%EB%B6%84%EC%84%9D%20%EC%9B%90%EC%9E%90%EB%A3%8C.xlshttp://ezstat.co.kr/real_life_sample/%EA%B5%AC%EB%A7%A4%EB%A0%A5%ED%8F%89%EA%B0%80%EC%84%A4/BigMac%EC%A7%80%EC%88%98%20%ED%9A%8C%EA%B7%80%EB%B6%84%EC%84%9D%20%EC%9B%90%EC%9E%90%EB%A3%8C.xlshttp://ezstat.co.kr/real_life_sample/%EA%B5%AC%EB%A7%A4%EB%A0%A5%ED%8F%89%EA%B0%80%EC%84%A4/BigMac%EC%A7%80%EC%88%98%20%ED%9A%8C%EA%B7%80%EB%B6%84%EC%84%9D%20%EC%9B%90%EC%9E%90%EB%A3%8C.xlshttp://ezstat.co.kr/real_life_sample/%EA%B5%AC%EB%A7%A4%EB%A0%A5%ED%8F%89%EA%B0%80%EC%84%A4/BigMac%EC%A7%80%EC%88%98%20%ED%9A%8C%EA%B7%80%EB%B6%84%EC%84%9D%20%EC%9B%90%EC%9E%90%EB%A3%8C.xls -
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5. Results
Test of =0 (not rejected)
Test of =1 (rejected)
36.105.42
31.5731.57
t
12.2104.0
181.181.1
t
(Exchange Rate) = -57.31 + 1.81 (BigMac)
http://ezstat.co.kr/real_life_sample/%EA%B5%AC%EB%A7%A4%EB%A0%A5%ED%8F%89%EA%B0%80%EC%84%A4/BigMac%EC%A7%80%EC%88%98%20%ED%9A%8C%EA%B7%80%EB%B6%84%EC%84%9D%20%EB%A1%9C%EA%B7%B8%EB%B3%80%ED%99%98%EC%A0%84.xlshttp://ezstat.co.kr/real_life_sample/%EA%B5%AC%EB%A7%A4%EB%A0%A5%ED%8F%89%EA%B0%80%EC%84%A4/BigMac%EC%A7%80%EC%88%98%20%ED%9A%8C%EA%B7%80%EB%B6%84%EC%84%9D%20%EB%A1%9C%EA%B7%B8%EB%B3%80%ED%99%98%EC%A0%84.xlshttp://ezstat.co.kr/real_life_sample/%EA%B5%AC%EB%A7%A4%EB%A0%A5%ED%8F%89%EA%B0%80%EC%84%A4/BigMac%EC%A7%80%EC%88%98%20%ED%9A%8C%EA%B7%80%EB%B6%84%EC%84%9D%20%EB%A1%9C%EA%B7%B8%EB%B3%80%ED%99%98%EC%A0%84.xlshttp://ezstat.co.kr/real_life_sample/%EA%B5%AC%EB%A7%A4%EB%A0%A5%ED%8F%89%EA%B0%80%EC%84%A4/BigMac%EC%A7%80%EC%88%98%20%ED%9A%8C%EA%B7%80%EB%B6%84%EC%84%9D%20%EB%A1%9C%EA%B7%B8%EB%B3%80%ED%99%98%EC%A0%84.xlshttp://ezstat.co.kr/real_life_sample/%EA%B5%AC%EB%A7%A4%EB%A0%A5%ED%8F%89%EA%B0%80%EC%84%A4/BigMac%EC%A7%80%EC%88%98%20%ED%9A%8C%EA%B7%80%EB%B6%84%EC%84%9D%20%EB%A1%9C%EA%B7%B8%EB%B3%80%ED%99%98%EC%A0%84.xls -
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5. Interpretation
is significantly different from one
Reject the Null
BigMac Index, reflecting purchasingpower, is not equal to the exchange
rate.
Why doesnt Purchasing Power Parity
hold?
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5. Look into data
existence of outlier
In most countries, BigMac index and exchangerates take a value in the range of 0-1,000. In a fewcountries, these values are quite extreme.
Absolute PPP vs. relative PPP.
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6. Model IIlogarithmic tranasformation-
Regress ln(Exchange Rate) on
constant and ln(BigMac index).
Test whether =1.
ln(Exchange Rate) = + ln(BigMac) +
http://ezstat.co.kr/real_life_sample/%EA%B5%AC%EB%A7%A4%EB%A0%A5%ED%8F%89%EA%B0%80%EC%84%A4/BigMac%EC%A7%80%EC%88%98%20%ED%9A%8C%EA%B7%80%EB%B6%84%EC%84%9D%20%EC%9B%90%EC%9E%90%EB%A3%8C.xlshttp://ezstat.co.kr/real_life_sample/%EA%B5%AC%EB%A7%A4%EB%A0%A5%ED%8F%89%EA%B0%80%EC%84%A4/BigMac%EC%A7%80%EC%88%98%20%ED%9A%8C%EA%B7%80%EB%B6%84%EC%84%9D%20%EC%9B%90%EC%9E%90%EB%A3%8C.xlshttp://ezstat.co.kr/real_life_sample/%EA%B5%AC%EB%A7%A4%EB%A0%A5%ED%8F%89%EA%B0%80%EC%84%A4/BigMac%EC%A7%80%EC%88%98%20%ED%9A%8C%EA%B7%80%EB%B6%84%EC%84%9D%20%EC%9B%90%EC%9E%90%EB%A3%8C.xlshttp://ezstat.co.kr/real_life_sample/%EA%B5%AC%EB%A7%A4%EB%A0%A5%ED%8F%89%EA%B0%80%EC%84%A4/BigMac%EC%A7%80%EC%88%98%20%ED%9A%8C%EA%B7%80%EB%B6%84%EC%84%9D%20%EC%9B%90%EC%9E%90%EB%A3%8C.xlshttp://ezstat.co.kr/real_life_sample/%EA%B5%AC%EB%A7%A4%EB%A0%A5%ED%8F%89%EA%B0%80%EC%84%A4/BigMac%EC%A7%80%EC%88%98%20%ED%9A%8C%EA%B7%80%EB%B6%84%EC%84%9D%20%EC%9B%90%EC%9E%90%EB%A3%8C.xlshttp://ezstat.co.kr/real_life_sample/%EA%B5%AC%EB%A7%A4%EB%A0%A5%ED%8F%89%EA%B0%80%EC%84%A4/BigMac%EC%A7%80%EC%88%98%20%ED%9A%8C%EA%B7%80%EB%B6%84%EC%84%9D%20%EC%9B%90%EC%9E%90%EB%A3%8C.xls -
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6. Model II (log transformed)
Due to log-transformation, the impact of outliers is reduced.
In line with relative PPP rather than absolute PPP, beta nowmeasures the percentage changes in the exchange ratesassociated with 1% increase in the BigMac index (concept of
elasticity).
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6. Results from Model II
Test of = 1 (cannot be rejected)
5.002.0
101.101.1
t
ln(Exchange Rate) = 0.29 +1.01 ln(BigMac)
http://ezstat.co.kr/real_life_sample/%EA%B5%AC%EB%A7%A4%EB%A0%A5%ED%8F%89%EA%B0%80%EC%84%A4/BigMac%EC%A7%80%EC%88%98%20%ED%9A%8C%EA%B7%80%EB%B6%84%EC%84%9D%20log-log%20%EB%AA%A8%ED%98%95.xlshttp://ezstat.co.kr/real_life_sample/%EA%B5%AC%EB%A7%A4%EB%A0%A5%ED%8F%89%EA%B0%80%EC%84%A4/BigMac%EC%A7%80%EC%88%98%20%ED%9A%8C%EA%B7%80%EB%B6%84%EC%84%9D%20log-log%20%EB%AA%A8%ED%98%95.xlshttp://ezstat.co.kr/real_life_sample/%EA%B5%AC%EB%A7%A4%EB%A0%A5%ED%8F%89%EA%B0%80%EC%84%A4/BigMac%EC%A7%80%EC%88%98%20%ED%9A%8C%EA%B7%80%EB%B6%84%EC%84%9D%20log-log%20%EB%AA%A8%ED%98%95.xls -
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6. Interpretation
is not significantly different from 1.
Cannot reject relative PPP
Conclude that 1% increase in the purchasing power
(as measured by the BigMac index) is associated with
the 1% increase in the exchange rate.
PPP holds in relative version, but not in absolute
version.
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THE END
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