Oil and the Naira: A Markov Switching Perspective

Idowu Ayodeji

African Development Review, 2017, vol. 29, issue 4, 562-574

Abstract: Using a Markov switching regression model, the study investigated the relationship between oil price shocks and exchange rates movements in an oil†exporting economy. On the strength of theoretical and empirical evidence, Nigerian naira exchange rates to US dollars were decomposed into two segmented time trends of depreciation (state 1) and appreciation (state 2). Empirical results provided evidence that exchange rate returns exhibited an asymmetric response to oil price shocks during depreciation and appreciation. We observed that, while the system is in depreciation, nominal oil prices had a positive influence on nominal USD/NGN, whereas nominal oil price shocks had no significant effect on nominal exchange rate movements during appreciation. In addition, real effective exchange rates appreciate with decreasing real oil prices but its depreciation does not depend significantly on real oil prices. Given that a decrease in nominal oil prices induces rapid naira depreciation and topples exchange rates stability, the study suggested that the government works towards a sustainable diversification of the economy to avoid continued over†dependence on oil exports. Also, to rigorously pursue a sustainable fiscal policy regime in order to boost local productions, encourage non†oil commodities exportation, and consequently increase avenues for influx of foreign exchange.

Date: 2017
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