Factors explaining exchange rate volatility in Nigeria: theory and empirical evidence

Abstract

The study empirically investigated the factors explaining the volatility of the bilateral exchange rate of the naira to the U.S. dollar, using data for 1970-2013 period. The EGARCH (1.1) modeling technique was used. The empirical evidence indicated that volatility of the naira exchange rate was characterised by clustering, strong leverage effect and moderate degree of persistence. It was found that increased net capital flows, greater integration of the Nigerian economy into the global market, deepening of the nation’s financial system, favourable crude oil prices, increase in the level of external reserves as well as economic growth were germane to dampening conditional volatility of the country’s exchange rate. It was also found that external debt and monetary expansion had the potential to exacerbate volatility in the exchange rate. Policies recommended to mitigate volatility of the exchange rate included greater integration of the economy into the global market, which implies diversification of the country’s export base, less reliance on external borrowing, building up and maintaining a robust external reserves position, financial system development and use of contractionary monetary policy to control broad money growth.