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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.

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  • Richard Clay Barnett, 2003. "Smuggling, non-fundamental uncertainty, and parallel market exchange rate volatility," Canadian Journal of Economics, Canadian Economics Association, vol. 36(3), pages 701-727, August.
    • Handle: RePEc:cje:issued:v:36:y:2003:i:3:p:701-727
    DOI: 10.1111/1540-5982.t01-2-00009
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    References listed on IDEAS

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    1. 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.
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    4. 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.
    5. Engineer, Merwan, 2000. "Currency transactions costs and competing fiat currencies," Journal of International Economics, Elsevier, vol. 52(1), pages 113-136, October.
    6. 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.
    7. 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.
    8. 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.
    9. 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.
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    Cited by:

    1. 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.
    2. 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.
    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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