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Exchange Rate Volatility and the extent of Currency Substitution in Nigeria

  • Yinusa, D. Olalekan
  • Akinlo, A.E.

This study tests for the existence of currency substitution and attempts to gauge its magnitude in Nigeria. The analysis was based on a multi-perspective unrestricted portfolio balance model. The stock of foreign currency deposits in Nigeria and the ratio of deposits denominated in foreign currency in the domestic banking system to deposits denominated in the domestic currency were modelled. First, the study revealed the presence of currency substitution in the domestic banking system in Nigeria. A major factor driving this process was exchange rate volatility especially real parallel market exchange rate volatility. Also, the study demonstrates that currency substitution in Nigeria was low during the period under review and as such classified Nigeria as moderately dollarized economy. Subsequently, alternative policy options for curtailing currency substitution in Nigeria were explored. The study concludes that currency substitution is an element of Nigerians’ behaviour concerning wealth allocation and as such macroeconomic policies that ensure long periods of low inflation and exchange rate stability become the most powerful policy option that could help stabilize or reduce currency substitution. Also very paramount are the development of domestic financial markets with relevant infrastructural facilities and the development of new financial instruments, which will serve as alternatives to holding money in the domestic economy.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 16257.

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Date of creation: 2008
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Publication status: Published in Indian Economic Review Issue No. 2..Vol. X(2008): pp. 161-181
Handle: RePEc:pra:mprapa:16257
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  1. Mizen, Paul & Pentecost, Eric J, 1994. "Evaluating the Empirical Evidence for Currency Substitution: A Case Study of the Demand for Sterling in Europe," Economic Journal, Royal Economic Society, vol. 104(426), pages 1057-69, September.
  2. Joannes Mongardini & Johannes Mueller, 2000. "Ratchet Effects in Currency Substitution: An Application to the Kyrgyz Republic," IMF Staff Papers, Palgrave Macmillan, vol. 47(2), pages 3.
  3. Miguel A. Savastano, 1996. "Dollarization in Latin America; Recent Evidence and Some Policy Issues," IMF Working Papers 96/4, International Monetary Fund.
  4. Luboš Komárek & Martin Meleck�, 2003. "Currency Substitution in a Transitional Economy with an Application to the Czech Republic," Eastern European Economics, M.E. Sharpe, Inc., vol. 41(4), pages 72-99, July.
  5. Girton, Lance & Roper, Don E, 1981. "Theory and Implications of Currency Substitution," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 13(1), pages 12-30, February.
  6. Edgar L. Feige & Michael Faulend & Velimir Sonje & Vedran Sosic, 2001. "Currency Substitution, Unoffical Dollarization and Estimates of Foreign Currency Held Abroad: The Case of Croatia," International Finance 0106001, EconWPA.
  7. William H. Branson & Dale W. Henderson, 1984. "The Specification and Influence of Asset Markets," NBER Working Papers 1283, National Bureau of Economic Research, Inc.
  8. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254.
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