Is Black Market Exchange Rate a Good Indicator of Equilibrium Exchange Rate? A Simple Test with Evidence from South Asia

Abstract

The black market exchange rate premium is widely used in the empirical literature as an indicator of trade and exchange rate distortions. This paper presents a simple test of the null hypothesis that the black market exchange rate is a reliable indicator of the equilibirum exchange rate. The evidence from India and Sri Lanka rejects the null, and thus raises serious doubts about the validity of the current empirical practice.