Purchasing Power Parity and Black Market Exchange Rate Nexus

Ghulam Shabbir and Amjad Naveed

Abstract

The main purpose of this study is to test the purchasing power parity for selected Asian countries using black market exchange rates. Though in previous studies the primary attention was given to the official exchange rate rather than the black market exchange rate, its importance cannot be ignored due to volume of transactions carried out in black market, which remained much larger than that in the official market. Therefore, an effort has been made to highlight the importance of black market exchange rates in testing the purchasing power parity (PPP) hypothesis. We used monthly data from ten selected Asian countries and the bound-testing approach to test the long run relationship between the black market exchange rate and relative prices. The study concluded that PPP hypothesis gets more support when the black market exchange rate and production price index are used instead of consumer price index. It appears that the official exchange rate is still managed, which is different than the actual market clearing exchange rate. In other words, the black market exchange rate is closer to market rates as compared to managed exchange rates.