Dual Exchange Markets under Incomplete Separation: An Optimizing Model

An optimizing model of dual exchange markets that are incompletely separated owing to the presence of fraudulent transactions is analyzed. The model is used to examine the implications of unanticipated and permanent changes in the commercial exchange rate and government spending. It is shown that these disturbances generate nonmonotonic responses in both the spread between the commercial and the financial rates and in capital flows. These results are contrasted with those obtained under complete market separation.