Value-at-risk modeling of naira exchange rates

Abstract

The naira exchange rate has experienced extreme volatility, and the use of derivatives to control interest rates and currency risks has grown quickly. These developments have made risk management research necessary. To this effect, this paper investigated the optimal volatility model that offers the best VaR forecasts and minimizes expected loss in the Naira exchange rate. The data was collected from FX time and consisted of the Euro to Naira exchange and the daily closing rate of the US dollar to Naira exchange rate from 24/10/2016 to 15/06/2018. These data were estimated using different symmetric and asymmetric GARCH models. The finding shows that there is less volatility in the USD to Naira exchange rate compared to the Euro to Naira exchange rate. The study shows that SPLINE- GJR under skewed student t distribution is the optimal model for the Euro to Naira exchange rate while GARCH is the optimal model for the US dollar to Naira exchange rate. This study suggests that model risk assessments be given careful consideration by regulators, banks, and other stakeholders and integrated into the process of operational and regulatory design.