FX Valuation Snapshot: FX Valuation Snapshot (May 2026)

Research evidence excerpt

FX Valuation Snapshot: FX Valuation Snapshot (May 2026)

d PPP. Traditional PPP involves deflating nominal trade-

weighted indices (TWIs) by goods prices to obtain real effective exchange rates

(REERs), and then comparing the REERs to historical averages to obtain valuations.

Cap-PPP involves deflating nominal capital-weighted indices (CWIs) by asset

prices to obtain real effective financial exchange rates (REFERs), and then

comparing the REFERs to historical averages to obtain valuations. More details

below, followed by a summary table

Construction of CWIs: In the construction of the CWI, we broadly follow the

methodology of Gelman et al (2015) and Lane and Shambaugh (2007). We consider

a wider range of currencies, however, including 18 EM currencies and the G10

currencies. The data on bilateral cross-holdings of portfolio assets (debt and equity)

is obtained from the IMF’s Coordinated Portfolio Investment Survey (CPIS). This

data is available on an annual basis from 2001-2015 (for 2016-17 we assume the

same capital weights as in 2015).

Using this data, we are able to construct an annual capital weights matrix involving

all countries. This matrix is akin to the trade weights matrix used in the construction

of TWIs, with the weights varying every year based on gross cross-border portfolio

holdings. We use gross (sum of assets and liabilities) rather than net cross-border

capital holdings, in line with both Gelman et al (2015) and the procedure followed

in constructing TWIs (where exports and imports are considered on a gross basis).

Gross holdings reflect the relative importance of capital partners better. For

example, partner countries with large, but equal, cross-border capital holdings

would sum to zero under a net approach. The capital weights matrix for the latest