Oil Price-Exchange Rate Interdependence: Relevance of Theory of Exchange Rate Overshooting in Nigeria

Abstract

This article investigated the interdependence between crude oil variability and foreign exchange rate changes in Nigeria. Oil price variability is decomposed into fluctuation on Brent Oil, West Texas Intermediate, OPEC Basket Reference Crude Oils and Bonny Light Crude Oil Price Variability. All the data that used in this research come from secondary sources. Annual time series data for Nigeria are used from 1993 to 2022. The research design for the study is ex post facto research analysis of annual multivariate time series data. The study examined the historical data in order to understand the current state of foreign exchange rate in Nigeria and causal connections crude oil price variability using ARDL Bound test, Johansen approach and Error-Correction Mechanism (ECM) models. In the long run, the coefficient of oil price volatility shows a positive and significant relation with the f o r e i g n e x c h a n g e r a t e at 10 percent level of significance. This implies that a 10 percent, increase in oil price volatility induces foreign exchange rate by 0.61 percent. The positive coefficient of oil price volatility tends to reveal that Dornbusch (1976) Overshooting hypothesis of foreign exchange rate holds for Nigeria. This finding is in conformity with previous studies like (Driskill & McCafferty, 1982); Turnovsky & Bhandari, 1982; Driskill & McCafferty, 1982). Furthermore, the coefficient of BOP and OPEC show a negative and insignificant relationship with the foreign exchange rate in the long run. This implies that BOP and OPEC hav e no impact on foreign exchange rate. This is in contrast with economic theory particularly Dutch diseases proposition and in conformity with foreign exchange rate overshooting theory. The negative nexus can be blamed on the inability of government to manage the foreign exchange supply and demand effectively in the country. Diversifying away from oil to other non-oil activities that would generate foreign exchange sh