What is Purchasing Power Parity (PPP)?
Quick Answer: PPP compares currencies based on the cost of identical goods, offering a long-term valuation benchmark for exchange rates.
Understanding Purchasing Power Parity (PPP)
Purchasing Power Parity compares currencies based on the cost of a common basket of goods. If identical goods cost more in one country, that currency is considered overvalued relative to PPP.
Applications
Economists use PPP to assess fair value of exchange rates over the long term. Traders monitor PPP deviations for macro investing themes or mean-reversion ideas.
Popular Measures
The IMF, OECD, and publications like The Economist's Big Mac Index provide PPP estimates. Compare them with market rates to gauge valuation extremes.
Limitations
PPP ignores capital flows, productivity differences, and non-traded goods. Exchange rates can remain misaligned for years due to cyclical or structural forces.
Avoid Timing Trades Solely on PPP
Use PPP as a strategic backdrop, not a tactical entry signal. Combine with momentum, policy outlook, and sentiment.
Related Terms
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