A Causal Analysis of Black and Official Exchange Rates: The Turkish Case By Vedat Akgiray, Kursat Aydogan, G. Geoffrey Booth and John Hatem C o n t e n t s : I. Introduction. - II. Exchange Rate Relationships. - III. Statistical Method. - IV. Data. - V. Empirical Results. - VI. Conclusions. I. Introduction D uring' the 1970"s, the foreign exchange market in Turkey was characterized by strict controls. The Turkish inflation rate in this decade was much higher than that of its trading partners, resulting in periodic devaluations. A strong black market emerged, which was fueled by the needs of importers to obtain foreign exchange and by the desire of Turkish workers in Western Europe to repatriate their funds. In 1981, the Turkish government began to remove some of the more stringent controls and to relax some others. At about the same time, it began providing daily quotes of official exchange rates. At the beginning of 1984, Turkish citizens were permitted to own foreign exchange and to have foreign currency denominated accounts with banks operating within the country. Combined, these changes had a three-fold effect. First, the changes resulted in a truly black market becoming an essentially free black market. Foreign exchange became a popular, conve- nient investment medium, a role that is undoubtedly enhanced by the lack of a well-functioning Turkish equity market and by the presence of interest rate ceilings. Second, the Central Bank of Turkey became able to implement more effectively its economic policies, particularly those concerned with the balance of payments. Third, commercial banks legally became able to participate in the official markets and their participation in the black markets was not expressly prohibited. As a by-product of these changes, daily black market exchange rate quotations became available in many national newspapers. The presence of these two parallel markets where both individuals and institutions can participate raises questions concerning the nature of the rela- tionship between the two markets. The purpose of this paper is to investigate the causal relationship between the Turkish official and black markets for the U.S. dollar and the West German mark, which are the currencies of Turkey's two major trading partners. To this end, hypotheses concerning the direction of causality are developed using Dornbusch's et al. [1983] and Olgun's [1984]