Investigating Spillover Effects between Foreign Exchange Rate Volatility and Commodity Price Volatility in Uganda

Lorna Katusiime

doi:10.3390/economies7010001

Abstract

This study investigates the impact of commodity price volatility spillovers on financial sector stability. Specifically, the study investigates the spillover effects between oil and food price volatility and the volatility of a key macroeconomic indicator of importance to financial stability: the nominal Uganda shilling per United States dollar (UGX/USD) exchange rate. Volatility spillover is examined using the Generalized Vector Autoregressive (GVAR) approach and Multivariate Generalized Autoregressive Conditional Heteroskedasticity (MGARCH) techniques, namely the dynamic conditional correlation (DCC), constant conditional correlation (CCC), and varying conditional correlation (VCC) models. Overall, the results of both the GVAR and MGARCH techniques indicate low levels of volatility spillover and market interconnectedness except during crisis periods, at which point cross-market volatility spillovers and market interconnectedness sharply and markedly increased. Specifically, the results of the MGARCH analysis show that the DCC model produces the best results. The obtained results point to an amplification of dynamic conditional correlations during and after the global financial crisis (GFC), suggesting an increase in volatility spillovers and interdependence between these markets following the global financial crisis. This is also confirmed by the results of the total spillover index based on the GVAR analysis, which shows low but time-varying volatility spillover that intensified during periods of high uncertainty and market crises, particularly during the global financial crisis and sovereign debt crisis periods.

Highlights

Over the years, growing integration and globalization has made the world’s economy more interdependent
The study focuses on the UGX/USD exchange rate, mainly because it accounts for a majority of foreign currency transactions in the Ugandan economy
This study investigates the volatility spillovers among commodity prices, namely food and oil, and the foreign exchange rate using multivariate generalized autoregressive conditional heteroskedasticity (MGARCH) models and Generalized Vector Autoregressive framework proposed by Diebold and Yilmaz (2012)

Summary

Introduction

Over the years, growing integration and globalization has made the world’s economy more interdependent. This interdependence in part reflects the success of decades of liberalization efforts, and is largely the result of expansion, diversification, and the deepening of trade and financial links between countries enhanced by technological developments. The resulting integration into the world economy raised the living standards in many African countries, and saw the rapid proliferation of telecommunication technology, the globalization of business activity, and increased policy and regulatory coordination. Economic integration has yielded numerous benefits, the resulting global interdependency of markets and economies has made countries more vulnerable to fluctuations in prices in the world market and global economic shocks in general.

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Conclusion