Abstract
Unlike the current measures in the literature, where corruption is constructed as an index, this paper provides a formula for quantifying corruption. By using option pricing techniques, the paper shows that the monetary value of a corrupt activity is equivalent to a regular bond and an embedded European call option. This formula is very important because it could be used to gauge the level resources lost to corrupt activities, and also to determine the level of “tax” that could be levied at corrupt-government officials. Results in the paper show that a government committed to reducing corruption should institute measures that will reduce the level and the volatility of the price of the goods in the parallel markets. The paper also finds that a government could reduce corruption by cutting interest rates, which would spur growth and render corruption as an unprofitable exercise.
Highlights
Despite the long history of corruption, modern research on economics of corruption began about 40 years ago with the work of [1]
Unlike the current measures in the literature, where corruption is constructed as an index, this paper provides a formula for quantifying corruption
The question asked in the paper is: in a corrupt environment, what is the price a corrupt government official must pay for the right to sell a government goods or services at a future date? This question is very important because in a country where it is very difficult for a government to curb corruption, it could impose a price or a special “tax” on its corrupt officials
Summary
Despite the long history of corruption, modern research on economics of corruption began about 40 years ago with the work of [1]. The purpose of this paper is to provide a method of measuring the size of corruption This is done by providing a formula for pricing a corrupt activity. This is a departure from the literature where the focus of research is on the aggregate determinants of corruption. The question asked in the paper is: in a corrupt environment, what is the price a corrupt government official must pay for the right to sell a government goods or services at a future date? The theoretical basis of the paper is to provide a pricing formula to value a corrupt activity. It draws on the option pricing literature by considering a corrupt activity as a European call option.
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