Economic and Political Institutions and Exchange Rate Volatility in Nigeria: Evidence from GARCH Models

Abstract

This study examined the effect of economic and political institutions on exchange-rate volatility in Nigeria over the period 1992–2022. Specifically, it investigated the effects of economic institutions, political institutions and their interaction on exchange-rate volatility. The study employed the Exponential Generalised Autoregressive Conditional Heteroskedasticity (EGARCH) model to estimate exchange-rate volatility and analyse the influence of institutional factors. The findings reveal that economic institutions have a positive and statistically significant effect on exchange-rate volatility. Similarly, the Polity II index has a positive and significant effect, whereas Constraints on Executive Power (CEP) exert a significant negative effect on exchange rate volatility. Furthermore, the interaction between economic institutions and Polity II is positive and significant, while the interaction between economic institutions and CEP is negative and significant. The EGARCH results also confirm the presence of persistent exchange-rate volatility in Nigeria. The study concludes that the effect of institutions on exchange-rate volatility depends on the quality of economic and political governance. It recommends strengthening institutional checks and balances, enhancing the independence and credibility of the Central Bank of Nigeria, improving transparency and accountability, and reducing political interference in exchange-rate management to promote exchange-rate stability and long-run macroeconomic stability.