Exchange Rate determination

I am referencing LOS 19.m (pp 100 book 2) Schweser says that “relative PPP is somewhat useful in exchange rate detminiation in the SHORT RUN” - I thought it could only be useful in the long run?

Maybe they mean that IS useful in the long-run and only SOMEWHAT useful in the short-run? If you ran a regression on it I would be that PPP would have some explanatory power (in the short-run), but not all that much. Just my guess.

The Relative PPP holds in the long run, but may not in the short run. So if you know that the real levels of a currency is, for example, 1USD = 1 EURO 5-years down the line, but presently it’s trading at 1 USD = 0.70 EURO, you atleast get the direction, if not the magnitude, in the short run, that the USD is going to appreciate to it’s long-term levels or the EURO will depreciate as it’s presently overvalued and will have to fall back to it’s true levels some day. Probably that’s what they want to imply, that we could base our long term trading strategies on the notion of Relative-PPP. But all-in-all this PPP is a $hit theory, if you could find the BMI Report (Big Mac Index) generated by Mac Donald’s you would go down laughing: http://en.wikipedia.org/wiki/Big_Mac_Index

Wa Wa, I haven’t read Schweser but my study partner told me about that quote. Dinesh’s explanation is correct, I think. Relative PPP is helpful for short run decision-making processes because it holds true over the long run.