The IMF Working Papers series is designed to make IMF staff research available to a wide audience. Almost 300 Working Papers are released each year, covering a wide range of theoretical and analytical topics, including balance of payments, monetary and fiscal issues, global liquidity, and national and international economic developments.
The literature on two-tier foreign exchange markets has concentrated on relating various shocks to the spread between the exchange rates relevant to the two tiers of the exchange market. In some earlier work we found that none of the typical predictions of theory held up empirically as BLEU spread explanations. In particular we could not find any domestic policy variables that significantly explained the BLEU spread. Our finding led us to reformulate two-tier market theory. We find that if domestic agents are risk neutral then no domestic policy variables are predicted to influence the spread.