Monday, July 25, 2022

How the Big Mac Index ID's undervalued currencies

At the current exchange rate ( £1=$1.21), £3.69*(1.21)=$4.46.   This means that if you could sell $4.46 to buy £3.69 in the FX market, buy big Mac's in London for £3.69, costlessly transport them to the US, and resell them for $5.15, you could earn ($5.15-$4.46)/$4.46=15.5%.  We say that the pound is 15.5% undervalued relative to the dollar.  The undervaluation implied by the index suggests that the British pound will eventually rise (in the long run).  Unfortunately the index doesn't tell us when this will occur.

Read more about the Big Mac index in the article "Dollar-euro parity may be justified.  But the yen looks cheap as chips."  You can also download the data or read the methodology behind the Big Mac Index here.

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