Price Formation in Illegal Markets: A Dynamical Approach

Abstract

This paper introduces a dynamical extension to the theoretical framework proposed by Slim (2009), where the author analyzes price formation in illegal markets. We develop a simple model with two regimes that can show a rich variety of dynamic behaviors, such as cyclical or even chaotic fluctuations without needing changes in exogenous variables. It is important to note that this analysis does not use random shocks to introduce irregular fluctuations; these arise because of the presence of intrinsic forces associated with nonlinear relations. This model can provide intuitions to explain price changes in illegal markets, particularly in drug ones, where price dynamics can become unpredictable given both the dangerous environment and the unequal degree of trust between the participants in these markets.

Keywords: price formation, illegal markets, nonlinear relations, chaos

JEL Classification: C6, D4, D5, D8, K4