A GAME OF EXCHANGE RATE DETERMINATION TO
ILLUSTRATE THE CONCEPT OF PPP
EMRE OZSOZ, PHD
FASHION INSTITUTE OF TECHNOLOGY - SUNY
CHALLENGE: HOW TO ILLUSTRATE THE CONCEPT OF FX RATE
DETERMINATION AND PPP CONCEPT PRINCIPLES COURSES
• Textbook reading
• Real World Examples
• School Trips
• HWs
Or ….
• In-class game on the concept
OVERVIEW OF THE GAME
FX Determination Game designed by following the work of
•
Rebelein et al. (2008) – corn and wheat purchasing
game;
•
Hazlett and Ganje (1999) – official and parallel FX
markets in a Dev. Economies
Goal of the game:
• Demonstrate to the students how exchange rates are
determined in a market environment.
• Illustrate the concept of law of one price and PPP in the case
of floating currencies.
• Demonstrate the concepts of inflation, shipping costs and
capital controls as part of the game through modifications
(treatments.)
OVERVIEW OF THE GAME
• Setting up the game
• Groups of 2-3, each group acting in self interest for
a reward – minimum 8 groups for best results
• Minimum 2 different currencies with different
denominations
• Several independent treatments to emphasize
different concepts (i.e. inflation, shipping costs)
THE RULES
• Students are given equal amounts of all currencies used
Ex: For a two currency game(green & blue) each group gets 40 units
of green currency + 20 units of blue currency
• A benchmark price for an international commodity is established.
Ex: Price of 1 oz. gold in green currency= 4 green currency; price of 1
oz. gold in blue currency=2 blue currency
• Students are then reminded that their initial purchasing power is
the same in both currencies.
Ex: 40 green currency = 10 oz. of gold (at the green currency
exchange rate) and 20 blue currency= 10 oz gold (at the blue
currency/ gold exchange rate.
• The groups than instructed to increase their purchasing power at
the end of a certain number of rounds (10-12) through
exchanging currency in the market.
• Reward necessary to reduce noise
DESIGNING MARKET EXCHANGE
Exchange mechanism
Free exchange
Best
implementation
results achieved
in rounds close to
convergence
Centralized Exchange
Block of currency
auctioned by the
instructor, measure of
randomness used to break
ties
SCORE BOARD
Randomly selected
auction amounts
Consistent FX rate
monitoring
enables students
to keep track
more easily
SCORE BOARD
Different Ways to
record the FX rate:
-Average of the
highest 3 bids
-The highest bid
Randomly selected
auction amounts
ACUAL RESULTS FROM A GAME
Exchange rate converges
to 2 Green = 1 Blue at the
end of the game
CONVERGENCE USUALLY ACHIEVED 60% INTO THE GAME
FOR 2 CURRENCY GAMES AND 80% INTO THE GAME FOR 3
CURRENCY GAMES WITHIN MY SAMPLE
LIMITATIONS
• Assumes the law of one price as the only
determinant of FX rate. Interest rates or
expectations ignored.
• Non-tradable goods hard to implement
• In the case of centralized exchange type
applications, randomness might determine the
winner.
POST CONVERGENCE TREATMENTS
• INFLATION:
By raising cost of commodity in a currency
• SHIPPING COSTS:
By establishing separate countries and imposing a
shipping cost for purchasing commodity from the
other country.
CAPITAL CONTROLS
Restriction on the amount of commodity that can be
purchased with one of the currencies.
DISCUSSION FOLLOWING THE GAME
• Better to lecture PPP discussion following the game
not before.
• Big Mac Index appropriate for discussion following
the game.