The Ratio Model and its Application: A Revisit

Zhang, Zhibai and Zou, Xinyue (2013): The Ratio Model and its Application: A Revisit. Published in: Journal of Applied Finance & Banking , Vol. 3, No. 6 (1 November 2013): pp. 67-86.

Abstract

In this paper, the ratio model, a simple currency valuation model proposed by Zhang (2012, International Research Journal of Finance and Economics, issue 97, pp. 55–59), is revisited. We use both the ratio and purchasing power parity (PPP) models to value the bilateral real exchange rates (RERs) of five Asian industrial countries and areas, namely, Japan, Korea, Taiwan, Hong Kong, and Singapore, against the United States. In the early 1950s to 2009, the RER misalignments of four new industrial countries and areas from the ratio model converged, but those from the PPP model did not, implying the competitiveness of the ratio model against the PPP model both in currency valuation and as an RER anchor. Based on the two models, from 2010 to 2011, the yen was shown to be overvalued by approximately 30%, whereas the Singapore dollar was undervalued by approximately 20%. However, the conclusions on the other three RERs were not consistent.

• Item Type: MPRA Paper
• Language: English
• Keywords: Equilibrium exchange rate; Absolute purchasing power parity; Penn effect; Ratio model
• Subjects: F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics; F - International Economics > F3 - International Finance > F31 - Foreign Exchange

References

[1] A.M. Alper and I. Civcir, Can Overvaluation Prelude to Crisis and Harm Growth in Turkey, Journal of Policy Modeling , 34, (2012), 112-131.

[2] B. Balassa, The Purchasing-Power Parity Doctrine: A Reappraisal, Journal of Political Economy, 72, (1964), 584-596.

[3] G. Barisone, R. Driver and S. Wren-Lewis, Are Our FEERs Justified? Journal of International Money and Finance, 25, (2006), 741-759.

[4] T. Bayoumi, H. Faruqee and J. Lee, A Fair Exchange? Theory and Practice of Calculating Equilibrium Exchange Rates, IMF Working Paper, No. 229, (2005).

[5] G. Cassel, The Present Situation of the Foreign Exchanges, The Economic Journal, 26, (1916a), 62–65.

[6] Cassel, G. The Present Situation of the Foreign Exchanges, The Economic Journal, 26, (1916b), 319-323.

[7] G. Chang and Q. Shao, How much Is the Chinese Currency Undervalued? A Quantitative Estimation, China Economic Review, 15, (2004), 366-371.

[8] Y. Cheung, M. Chinn and E. Fujii, Measuring Renminbi Misalignment: Where do We Stand? Korea and the World Economy, 11, (2010), 263-296.

[9] M. Chinn, Three Measures of East Asian Currency Overvaluation, Contemporary Economic Policy, 18, (2000), 205-214.

[10] P. Clark and R. MacDonald, Exchange Rates and Economic Fundamentals: A Methodological Comparison of BEERs and FEERs, IMF Working Paper, No. 67, (1998).

[11] S. Dunaway, L. Leigh and X. Li, How Robust Are Estimates of Equilibrium Real Exchange Rates: The Case of China, Pacific Economic Review, 14, (2009), 361-375.

[12] J. Frankel, On the Yuan: The Choice between Adjustment under a Fixed Exchange Rate and Adjustment under a Flexible Rate, CESifo Economic Studies, 52, (2006), 246-275.

[13] C. Garroway, B. Hacibedel, H. Reisen and E. Turkisch, The Renminbi and Poor-Country Growth, The World Economy, 35, (2012), 273-294.

[14] P. Imam and C. Minoiu, The Equilibrium Exchange Rate of Mauritius: Evidence from Two Structural Models, Emerging Markets Finance & Trade, 47, (2011), 134-147.

[15] P. Isard, Equilibrium Exchange Rates: Assessment Methodologies, IMF Working Paper, No. 296, (2007).

[16] T. Ito, P. Isard and S. Symansky, Economic Growth and Real Exchange Rate: An Overview of the Balassa-Samuelson Hypothesis in Asia, NBER Working Paper, No. 5979, (1997).

[17] A. Lopez-villavicencio, J. Mazier and J. Saadaoui, Temporal Dimension and Equilibrium Exchange Rate: A FEER/BEER Comparison, Emerging Markets Review, 13, (2012), 58-77.

[18] K. Ohno, Estimating Yen/Dollar and Mark/Dollar Purchasing Power Parities, IMF Staff Papers, 37, (1990), 700-725.

[19] D. Rodrik, The Real Exchange Rate and Economic Growth, Brookings Papers on Economic Activity, 2, (2008), 365-412.

[20] K. Rogoff, The Purchasing Power Parity Puzzle, Journal of Economic Literature, 34, (1996), 647-668.

[21] P. Samuelson, Facets of Balassa-Samuelson Thirty Years Later, Review of International Economics, 2, (1994), 201-226.

[22] K. Sato, J. Shimizu, N. Shrestha and Z. Zhang, New Estimates of the Equilibrium Exchange Rate: The Case for the Chinese Renminbi, The World Economy, 35, (2012), 419-443.

[23] H. Shatz and D. Tarr, Exchange Rate Overvaluation and Trade Protection: Lessons from Experience, World Bank Policy and Research Working Paper, No. 2289, (2000).

[24] N. Z. M. Sidek, M. B. Yusoff, G. Ghani and J. Duasa, Malaysia’s Palm Oil Exports: Does Exchange Rate Overvaluation and Undervaluation Matter? African Journal of Business Management, 5, (2011), 11219-11230.

[25] F. Takeuchi, How Undervalued Is the Chinese Yuan? A New Examination of Purchasing Power Parity, Japan Center for Economic Research Researcher Report, No. 23, (2003).

[26] A. Taylor and M. Taylor, The Purchasing Power Parity Debate, The Journal of Economic Perspectives, 18, 135-158.

[27] H. Tong, Nonlinear Time-series: A Dynamical Systems Approach, Oxford University Press, Oxford, (1990).

[28] Y. Wang, X. Hui and A. Soofi, Estimating Renminbi (RMB) Equilibrium Exchange Rate, Journal of Policy Modeling, 29, (2007), 417-429.

[29] Y. Xu, China’s Exchange Rate Policy, China Economic Review, 11, (2000), 262-277.

[30] J. Yang and I. Bajeux-Besnainou, Is the Chinese Currency Undervalued? International Research Journal of Finance and Economics, (2), (2006), 106-130.

[31] Z. Zhang, Understanding the Behavioral Equilibrium Exchange Rate Model via Its Application to the Valuation of Chinese Renminbi, http://mpra.ub.uni-muenchen.de/40648/, (2010), (May 2013, date accessed).

[32] Z. Zhang, A Simple Model and Its Application in the Valuation of Eleven Main Real Exchange Rates, International Research Journal of Finance and Economics, (97), (2012), 55-59.