The Adjusted Big Mac Methodology: A Clarification |
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| Authors: | Thomas J O'Brien Santiago Ruiz de Vargas |
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| Institution: | 1. Department of Finance, School of Business, University of Connecticut, Storrs, CT;2. Financial Advisory Services, NOERR AG, Wirtschaftsprüfungsgesellschaft Steuerberatungsgesellschaft, Munich, Germany |
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| Abstract: | The Economist's adjusted Big Mac index takes GDP into account in currency valuation, but the methodology is not explained. We show that the key to understanding the methodology is to distinguish between a currency's bilateral valuation (versus a specific currency) and the currency's overall valuation (versus a “basket” of a large number of currencies). Also, the adjusted Big Mac estimates of intrinsic foreign exchange (FX) rates have been better forecasts of actual FX changes than those of the original “raw” Big Mac index. |
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