Financial stress and exchange rate volatility in Sub-Saharan Africa: Evidence from new datasets

Aliyu Rufai, Isaiah Udaah and Afees Salisu

MPRA Paper from University Library of Munich, Germany

Abstract: This study utilizes a newly constructed index for financial stress to examine its predictive value for exchange rate volatility in sub-Saharan Africa (SSA). Using a methodology that accounts for the key features of the predictive model, we find that financial stress significantly and positively affects exchange rate volatility in SSA. This indicates that increased financial stress is linked to higher levels of exchange rate volatility in the region. A robustness check conducted on OECD countries shows that financial stress does not elevate exchange rate volatility in those countries. These findings support the purchasing power parity (PPP) theory in SSA, where financial stress amplifies exchange rate fluctuations, whereas in OECD countries, the effects are weaker and less statistically significant. In light of these findings, policymakers in sub-Saharan Africa should prioritize enhancing the financial system stability to better protect against external shocks.

Keywords: Exchange rate volatility; Financial stress; Sub-Saharan Africa; Purchasing power parity (search for similar items in EconPapers)
JEL-codes: C58 D53 G15 (search for similar items in EconPapers)
Date: 2023-12-23
New Economics Papers: this item is included in nep-fdg and nep-mon
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