Testing PPP Theory Using the Big Mac Index and the Starbucks Index

Abstract

This paper outlines two indices – Big Mac Index and the Starbucks Grande Latte Index – used to test for whether purchasing power parity holds in the selected four countries – Canada, Hong Kong, Taiwan and Switzerland. US dollars was used as the base currency to test for over/under valuation and to see whether exchange rates for each of the four currencies move in respect to the over/under percentage values. The over/under valuation percentage values for each year are calculated using the following formula: (Implied exchange rate – Actual exchange rate) / (Actual exchange rate) x 100%

The implied exchange rate for each year is calculated using the following formula: (Foreign Currency/Base US Currency) The over/under percentage values were then graphed and superimposed over the currency exchange rate graph for each of the four countries to test whether PPP holds for each country based on each of the two indices.