Oil price Volatility and Exchange rate Dynamics in Nigeria: A Markov Switching Approach

The paper examines the spillover effect of crude oil price shocks to exchange rate movement of appreciation and depreciation in Nigeria using monthly data ranging from January 2004- June 2019. The study employed a two stage heteroskedastic Markov switching model. Results from preliminary investigations reveal that both Crude oil prices and exchange rate series are characterized with non- normal distribution, presence of unit root and ARCH effects. Also the BDS, Bai-Perron and Cusum Q tests are conducted to figure out the nonlinearities and structural breaks in the data. The result obtained from the estimated model indicated a positive relationship between oil prices and exchange rate in regime 1(depreciation regime) and negative relationship in regime 2 (appreciation regime). Further analysis reveals that low volatility appreciation regime is more persistent than high volatility deprecation regime with transitional probabilities 0.97 and 0.39 respectively. Consistently the expected duration of stay reveals that duration of stay in the appreciation regime is higher than in the depreciation regime at 35.92 months and 1.6 months respectively. Further, analysis of volatility spillover between oil prices and exchange rate reveals that a rise in oil prices leads to appreciation of the Naira and conversely negative shock in oil prices cause a consequent deprecation of the local currency. Certainly the findings are shall be of utmost relevance to monetary authorities.