Estimating The Time-Variant Co-Movement Of Exchange Rate Volatility And Consumer Price Returns In Nigeria

Abstract

This study examined the dynamic co-movement between the exchange rate volatility and consumer price returns (inflation) in Nigeria. The study adopted DCC-GARCH approach to observe if there exist variations in the correlation between the two variables over different periods using a monthly time series data spanning the period of 2009M1 - 2024M12. The results indicate that the constant mean in the conditional mean equation of exchange rate returns is statistically insignificant. Likewise, the constant of conditional variance equation of CPI returns. However, the parameters in both the mean and the variance equations of the two variables are statistically significant at least at 10 percent level, including the ARCH and the GARCH terms in the two equations. Equally, the sums of α+β in both conditional variance equations are almost 1.2 indicating a somewhat low persistence in the conditional variances. For the dynamic correlation, its mean-value is estimated to be around 0.105 which shows an unconditional positive, although weak, correlation between returns on exchange rate and inflation in Nigeria over the study period. However, the result of parameter constancy test (chi-square statistic) indicates strong evidence against the hypothesis of a constant conditional coefficient. The result shows that R_t is different from R at 1 percent level. Thus, we conclude that there is evidence of dynamism in the conditional correlation between the variables. Depicting the dynamism, we observed that periods of 2011M1, 2019M1 and 2020M8 recorded the lowest correlation (the lowest level of pass-through), while 2011M3 and 2012M6 witnessed a somewhat highest correlation between the two volatilities, until Retail DAS (RDAS) was re-implemented towards the end of July 2013. The paper therefore recommends auction of sufficient foreign exchange by the CBN and unification of exchange rates for adequate predictability of inflation rates by the monetary authority.