Volatility of Exchange Rate in Nigeria: An Investigation of Risk on Investment

Abstract

The contribution of investment in currency trading in economic growth of a nation cannot be over emphasized. Hence, the examination of the risk involved in such trading because of volatility in foreign exchange rate. Time series data and model were used in this study. The monthly exchange rate of four major foreign currencies in Nigeria namely the US Dollars (USD), the Great Britain Pounds (GBP), the EURO and CFA Francs against Nigerian Naira (NGN) from January, 2004 to December, 2019 were extracted from website of Central Bank of Nigeria (CBN) with an open access to the public. Due to the volatile nature of the exchange rate, the Generalized Autoregressive Conditional Hetroscedastic (GARCH) model was a suitable model used at order 1 for parsimony to determine volatility used in computing Value at Risk (VaR). It was discovered that the maximum loss (risk), measured by VaR, that can occur at 95% confidence interval for twelve months forecast of trading with GBP was the highest, among the four currencies, with percentage loss of between 15.5% to 16.2%. While the CFA has the lowest risk with VaR between 0.02% to 0.03%. Based on the findings, the risk of investing in foreign exchange is the highest when trading in GBP with attendant high returns due to large fluctuations up and down of the exchange rate. This study will help investors to study the pattern of risk and returns and decide on the foreign currency to trade on. The government should put policies in place to encourage existing investors and new investors that want to invest on foreign exchange to create employment, since the risk involved can be determined as it is done in this study.