Oil Price and Exchange Rate Volatility in Nigeria

Nigeria being a mono-product economy, where the main export commodity is crude oil, changes in oil prices has implications for the Nigerian economy and, in particular, exchange rate movements. The latter is mostly important due to the double dilemma of being an oil exporting and oil-importing country, a situation that emerged in the last decade. The study examined the effects of oil price, external reserves and interest rate on exchange rate volatility in Nigeria using annual data covering the period 1970 to 2011. The theoretical framework of this study is based on Generalized Autoregressive Conditional Heteroskedasity modeled by Tim Bolerslev (1986) and Exponential General Autoregressive Conditional heteroskedastic modeled by Daniel Nelson (1991). These models were used to estimate the relationship between oil price changes and exchange rate. Relevant descriptive and econometric analyses were employed. The econometric tests adopted include the unit root tests, Johansen co-integration technique and the Vector Error Correction Model (VECM); the time series property examined shows that all the variables were stationary at first difference. The long run relationship among the variables was determined using the Johansen Co-integration technique while the vector correction mechanism was used to examine the speed of adjustment of the variables from the short run dynamics to the long run. It was observed that a proportionate change in oil price leads to a more than proportionate change in exchange rate volatility in Nigeria; which implies that exchange rate is susceptible to changes in oil price. The study therefore recommend that the Nigeria government should diversify from the Oil sector to other sectors of the economy so that Crude oil will no longer be the mainstay of the economy and frequent changes in crude oil price will not influence exchange rate volatility significantly in Nigeria.