Endogenous Structural Breaks and Real Exchange Rate Determination in Nigeria since Interbank Foreign Exchange Market (IFEM)

Omotosho, Babatunde S. (2012): Endogenous Structural Breaks and Real Exchange Rate Determination in Nigeria since Interbank Foreign Exchange Market (IFEM). Published in: CBN Economic and Financial Review , Vol. 50, No. 3 (2012)

Abstract

Starting from Obaseki (1998), several authors have developed different models of Naira equilibrium real exchange rate in a bid to better understand its behavior, albeit without accounting for the possibility and effects of structural breaks in their models. This is counterintuitive, especially in view of exchange rate policy changes in Nigeria over the years and the occurrence of global shocks resulting from the 2008/09 financial crisis. This paper reexamines the concept of naira real exchange rate determination in the spirit of Edwards (1989), while allowing for the effects of endogenously determined structural breaks in the cointegrating vector. The results were revealing. First, three endogenous break dates were identified over the estimation period of 2000-2011, which were 2002:Q3, 2003:Q2 and 2009:Q3. Second, we found faster speed of adjustment to long run equilibrium after accounting for the effects of the identified structural breaks. Third, the model without structural breaks underestimated the misalignment level by about 250 basis points on the average. Fourth, the nominal exchange rate (an indicator of exchange rate policy) was found to be very crucial in steering the RER towards its long run equilibrium path. Fifth, the level of naira misalignment was found to be about 0.001 per cent since the introduction of WDAS, much lower than the 0.89 and 0.21 recorded during IFEM and RDAS, respectively. The study therefore calls for the retention of the current exchange rate policy (WDAS) in the country as a way of ensuring that the Naira is kept within its path of long run equilibrium.

• Item Type: MPRA Paper
• Language: English
• Keywords: Real exchange rate, cointegration, structural breaks, misalignment, overvaluation, undervaluation
• Subjects: C - Mathematical and Quantitative Methods > C2 - Single Equation Models ; Single Variables > C22 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies; F - International Economics > F3 - International Finance > F31 - Foreign Exchange

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