PPP vs Market FX
first posted: 2025-01-11 13:28:08.457518
In the Triumph of the Optimists, Dimson Marsh and Staunton published an article about currency exchange rates and purchasing power parity (PPP). The main point is that evolution of PPP should follow the differential of inflation rate.
They show a graph of "real exchange rate" which collapsed in Germany during Weimar 1922 inflation and goes back to parity. one might surmise that the rebased real exchange rate is PPP/fx rebased to some year.
We get data from IMF for PPP and Yahoo for fx markets:
- We show below the Purchasing Power Parity data from the IMF. The currency is overvalued w.r. to USD if the blue line is above the orange.
- The PPP after 2019 is estimated, it seems that the estimate is based on latest PPP + inflation differential, although the IMF does not say so. The quality of such estimates is relatively low as far as we can judge for Turkish Lira, which saw huge variations of PPP in 2020-2022.
- The currencies selected below correspond to those for which IB is publishing benchmark rates. It seems that at the time of publishing, every country cost of living is cheaper than the US except for Switzerland.
- The PPP and fx spot are expected to converge, any significant short term divergence would be expected to mean revert, however, to trade this, one has to assume that no structural change is taking place.
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