<abstract xmlns="http://www.w3.org/1999/xhtml">

This paper aims to analyse the dynamics of foreign exchange markets in a country facing political uncertainty that prompt capital outflow from the country1. The economic environment under investigation is characterized by dual foreign exchange markets: a formal or official market for foreign exchange with insufficient and volatile foreign exchange flows, and a strong and thriving informal market, with a higher exchange rate2. The findings in the paper indicate a necessary condition for stabilization of the exchange rate system and that is that the return on investment should exceed the depreciation rate of domestic currency in the formal foreign exchange market. This condition implies that the return on investment should at least compensate investors for the opportunity cost of holding domestic money in their private portfolio wealth. Our findings also indicate that stability of the foreign exchange rates is more difficult to achieve under insufficient official reserves as the recovery process from a shock becomes more costly in terms of time period needed for the adjustment process to complete. The dynamic path of the foreign exchange premium shows that under massive capital outflow caused by economic sanctions, the informal market exchange rate overshoots the equilibrium stationary exchange rate, and the size of such overshooting depends on the size of available foreign exchange reserves held by the central bank.
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This paper aims to analyse the dynamics of foreign exchange markets in a country facing political uncertainty that prompt capital outflow from the country1. The economic environment under investigation is characterized by dual foreign exchange markets: a formal or official market for foreign exchange with insufficient and volatile foreign exchange flows, and a strong and thriving informal market, with a higher exchange rate2. The findings in the paper indicate a necessary condition for stabilization of the exchange rate system and that is that the return on investment should exceed the depreciation rate of domestic currency in the formal foreign exchange market. This condition implies that the return on investment should at least compensate investors for the opportunity cost of holding domestic money in their private portfolio wealth. Our findings also indicate that stability of the foreign exchange rates is more difficult to achieve under insufficient official reserves as the recovery process from a shock becomes more costly in terms of time period needed for the adjustment process to complete. The dynamic path of the foreign exchange premium shows that under massive capital outflow caused by economic sanctions, the informal market exchange rate overshoots the equilibrium stationary exchange rate, and the size of such overshooting depends on the size of available foreign exchange reserves held by the central bank.

The impact of a political shock on foreign exchange markets in a small and open economy: A dynamic modelling approach

Journal of Central Banking Theory and Practice

This work is licensed under the Creative Commons Attribution 4.0 International License.

This paper aims to analyse the dynamics of foreign exchange markets in a country facing political uncertainty that prompt capital outflow from the country1....

The impact of a political shock on foreign exchange markets in a small and open economy: A dynamic modelling approach

Published Online: Sep 06, 2021

Page range: 137 - 152

Received: May 27, 2020

Accepted: Oct 27, 2020

DOI: https://doi.org/10.2478/jcbtp-2021-0028

Keywords
dynamic model, foreign exchange markets, political uncertainty, stability analysis, economic sanctions

© 2021 Ibrahim A. Onour et al., published by Sciendo

This work is licensed under the Creative Commons Attribution 4.0 International License.

The impact of a political shock on foreign exchange markets in a small and open economy: A dynamic modelling approach

Published Online: Sep 06, 2021

Page range: 137 - 152

Received: May 27, 2020

Accepted: Oct 27, 2020

DOI: https://doi.org/10.2478/jcbtp-2021-0028

Keywordsdynamic model, foreign exchange markets, political uncertainty, stability analysis, economic sanctions

© 2021 Ibrahim A. Onour et al., published by Sciendo

This work is licensed under the Creative Commons Attribution 4.0 International License.

Keywords
dynamic model, foreign exchange markets, political uncertainty, stability analysis, economic sanctions