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

Abstract This paper aims to analyse the dynamics of foreign exchange markets in a country facing political uncertainty that prompt capital outflow from 1 . The economic environment under investigation is characterized by dual markets: formal or official market for with insufficient and volatile flows, strong thriving informal market, higher rate 2 findings indicate necessary condition stabilization system return on investment should exceed depreciation domestic currency market. implies at least compensate investors opportunity cost holding money their private portfolio wealth. Our also stability rates more difficult achieve reserves as recovery process shock becomes costly terms time period needed adjustment complete. dynamic path premium shows massive caused sanctions, overshoots equilibrium stationary rate, size such overshooting depends available held central bank.