E M R E O Z S O Z , P H DF A S H I O N I N S T I T U T E O F T E C H N O L O G Y - S U N Y

A GAME OF EXCHANGE RATE DETERMINATION TO ILLUSTRATE THE CONCEPT OF PPP

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 usedEx: 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

SCORE BOARD

Randomly selected auction amounts

Consistent FX rate monitoring enables students to keep track more easily

Different Ways to record the FX rate: -Average of the highest 3 bids-The highest bid

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 CONTROLSRestriction 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.