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Smuggling, non‐fundamental uncertainty, and parallel market exchange rate volatility

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  • Richard Clay Barnett

Abstract

. We explore a model where smuggling and a parallel currency market arise, owing to government restrictions that prevent agents from legally holding foreign exchange. Despite such restrictions, agents are able to diversify their savings, holding both domestic and parallel foreign cash, basing their portfolio allocation on current and prospective parallel exchange rates. We attribute movements in parallel rates to non‐fundamental uncertainty. The model generates equilibria with both positive and negative parallel premia and correlations between illegal trade and the premium. The model has the novel implication that currency speculation drives smuggling, affecting real activities in all sectors of the economy. JEL classification: F31 Contrebande, incertitude non fondamentale, et volatilité du taux de change dans des marchés parallèles. L’auteur développe un modèle où contrebande et marché parallèle de la devise émergent à cause des restrictions gouvernementales qui empêchent les agents de détenir légalement des devises étrangères. Malgré ces restrictions, les agents sont en mesure de diversifier leurs épargnes: détenant à la fois la devise locale et des liquidités en devises étrangères obtenues sur le marché parallèle, et construisant la structure de leur portefeuille à partir d’un examen des taux de change parallèles présent et prospectifs. On attribue les mouvements dans les taux parallèles à une incertitude non fondamentale. Le modèle engendre des équilibres avec des primes parallèles positives et négatives, et des corrélations entre le commerce illégal et la prime. Le modèle suggère de façon inédite que la spéculation sur les devises est à la source de la contrebande, et que cela affecte les activités économiques réelles dans tous les secteurs de l’économie.

Suggested Citation

  • Richard Clay Barnett, 2003. "Smuggling, non‐fundamental uncertainty, and parallel market exchange rate volatility," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 36(3), pages 701-727, August.
  • Handle: RePEc:wly:canjec:v:36:y:2003:i:3:p:701-727
    DOI: 10.1111/1540-5982.t01-2-00009
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    1. Soller Curtis, Elisabeth & Waller, Christopher J., 2000. "A search-theoretic model of legal and illegal currency," Journal of Monetary Economics, Elsevier, vol. 45(1), pages 155-184, February.
    2. King, Robert G. & Wallace, Neil & Weber, Warren E., 1992. "Nonfundamental uncertainty and exchange rates," Journal of International Economics, Elsevier, vol. 32(1-2), pages 83-108, February.
    3. Woodford, Michael, 1987. "Three Questions about Sunspot Equilibria as an Explanation of Economic Fluctuations," American Economic Review, American Economic Association, vol. 77(2), pages 93-98, May.
    4. Alan Deardorff & Wolfgang Stolper, 1990. "Effects of smuggling under african conditions: A factual, institutional and analytic discussion," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 126(1), pages 116-141, March.
    5. Manuelli, Rodolfo E & Peck, James, 1990. "Exchange Rate Volatility in an Equilibrium Asset Pricing Model," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 31(3), pages 559-574, August.
    6. Philip R. Lane, 1999. "What Determines the Nominal Exchange Rate? Some Cross Sectional Evidence," Canadian Journal of Economics, Canadian Economics Association, vol. 32(1), pages 118-138, February.
    7. John Kareken & Neil Wallace, 1981. "On the Indeterminacy of Equilibrium Exchange Rates," The Quarterly Journal of Economics, Oxford University Press, vol. 96(2), pages 207-222.
    8. Bernett, Richard C., 1992. "Speculation, incomplete currency market participation, and nonfundamental movements in nominal and real exchange rates," Journal of International Economics, Elsevier, vol. 33(1-2), pages 167-186, August.
    9. Engineer, Merwan, 2000. "Currency transactions costs and competing fiat currencies," Journal of International Economics, Elsevier, vol. 52(1), pages 113-136, October.
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    Cited by:

    1. Farzanegan, Mohammad Reza, 2009. "Illegal trade in the Iranian economy: Evidence from a structural model," European Journal of Political Economy, Elsevier, vol. 25(4), pages 489-507, December.
    2. Emmanuel Ekow Asmah & Francis Kwaw Andoh & Edem Titriku, 2020. "Trade misinvoicing effects on tax revenue in sub‐Saharan Africa: The role of tax holidays and regulatory quality," Annals of Public and Cooperative Economics, Wiley Blackwell, vol. 91(4), pages 649-672, December.
    3. Dujava, Daniel & Siranova, Maria, 2022. "Is it me or you? A deeper insight into profile of misreporting economies," The Quarterly Review of Economics and Finance, Elsevier, vol. 83(C), pages 10-25.
    4. Patricia Sourdin & Richard Pomfret, 2012. "Trade Facilitation," Books, Edward Elgar Publishing, number 14596.

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    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange

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