| The black market premium (henceforth referred to as BMP), defined as the percentage difference between the black market rate and the official rate in the foreign exchange market, is widely used in the literature on international economics as a measure of deviation from market activity. The BMP is also used in economic growth literature as a measure of the distortion caused by inappropriate policies adopted by the government. Most recently the BMP has also been used as a measure of capital controls in cross-country growth regressions. The main body of literature considers this as an exogenous variable; as such it enters on the right hand side of the regressions in a single equation system. Very few studies have attempted to identify the determinants of the BMP where the variable is treated as endogenous.; Soon after the publication of the seminal paper by Dornbusch et al. (1983) the focus has mainly been on the empirical verification of their theory in a time series framework. Institutional factors, defined as the rules and regulations that govern an economy, society, and politics, play an important role in determining the premium in the sense that many of the institutions affect either the demand for or the supply of black market foreign exchange. This may be one additional channel that can explain why the premium is alleged to be very high in developing countries.; In this dissertation, I investigate the impact of institutional factors, such as democracy, corruption, smuggling, and military spending, on the BMP. After controlling for other important determinants, I show that institutional rigidities, such as lack of democracy, which manifests itself through depressed political rights and civil liberties as well as corruption, smuggling, and military spending result in a higher BMP. The empirical results are based on unbalanced panel regressions using data from many developing countries for many years (depending on data availability) in five different panel estimations. The result still holds even if I control for individual country and or time heterogeneity within developing countries.; This dissertation is expected to provide a guide for policy makers as to the impact of institutional reforms of the type discussed above in lowering the size of the BMP in developing countries. |
