Modelling oil price shocks and exchange rate behaviour in Nigeria – A regime‐switching approach

Abstract

AbstractConsequent upon the intermittent variations in the global oil prices over the years and its attendant effects on exchange rate dynamics of oil‐rich economies, the study investigates the regime‐switching behaviour of oil price shocks and exchange rate behaviour in Nigeria. The period of investigation spans 1980q1 – 2020q4 and the technique of analysis is the Markov‐Switching Dynamic Regression. Predicated on an extended portfolio balancing theory, the unit‐root test with structural break confirms break points in the data. The Markov‐Switching Dynamic Regression shows the presence of two regimes of low and high global oil price shocks in the data. Additional results show that expectation plays a huge role in the oil price and exchange rate nexus in Nigeria and that the regime of low global oil price comes with more shock effects than that of high global price of oil. With short memory property, both the low and high global prices of oil exhibit high persistence level above 70 percent but the duration of persistence for the latter is half‐life the former. The study recommends that the monetary authority should introduce exchange rate policy surprise and further diversify the economy from oil dependence.