Money and Foreign Exchange Markets Dynamics in Nigeria: A Multivariate GARCH Approach

Atoi, Ngozi Victor and Nwambeke, Chinedu G. (2021): Money and Foreign Exchange Markets Dynamics in Nigeria: A Multivariate GARCH Approach. Published in: Central Bank of Nigeria Journal of Applied Statistics , Vol. 12, No. 1 (31 June 2021): pp. 109-138.

Abstract

This study examines money market and foreign exchange market dynamics in Nigeria by estimating the dynamic correlation and volatility spillovers between Nigeria Naira/US Dollar Bureau De Change (BDC) exchange rate and interbank call rate with data from January 2007 to August 2019. The study employs a dynamic conditional correlation form of GARCH model (DCC-GARCH) to access the nature of correlation, while an unrestricted bivariate BEKK-GARCH (1, 1) form of multivariate GARCH model is utilized to investigate shocks and volatility spillover of the rates. The estimated DCC-GARCH (1, 1) reveals that interest rate and exchange rate are dynamically linked negatively, suggesting that exchange rate (or interest rate) is inversely sensitive to interest rate (or exchange rate) in Nigeria. This result was substantiated by the estimated BEKK-GARCH(1, 1) model. Furthermore, the effects of news (shocks spillover) are bi-directional across the markets. However, volatility spillover is unidirectional, from exchange rate to interest rate, suggesting that, calming the volatility in foreign exchange market does guarantee moderation of volatility in the money market, whereas the reverse is not the case. The results underscore the growing influence of foreign exchange market in the financial space of the Nigerian economy. Thus, the study recommends that foreign exchange policies aimed at maintaining exchange rate stability should be sustained, having found exchange rate to be more effective in moderating interest rate volatility in Nigeria.

• Item Type: MPRA Paper
• Language: English
• Keywords: Exchange rate, interest rate, multivariate GARCH, volatility spillover
• Subjects: C - Mathematical and Quantitative Methods > C4 - Econometric and Statistical Methods: Special Topics; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; F - International Economics > F3 - International Finance > F31 - Foreign Exchange; G - Financial Economics > G1 - General Financial Markets > G10 - General

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