Modelling oil price shocks and exchange rate behaviour in Nigeria – A regime‐switching approach

• Published date: 01 March 2023
• Author: Taofeek Olusola Ayinde,Farouq Adekunmi Adeyemi,Busrah Agbaje Ali‐Balogun
• Date: 01 March 2023
• DOI: http://doi.org/10.1111/opec.12263

Department of Economics, Fountain

University, Oke-Osun, Nigeria

Correspondence

Taofeek Olusola Ayinde, Department of

Economics, Fountain University,P.M. B.

4491, Oke-Osun, Osun State, Nigeria.

Email: olusolaat@gmail.com

Abstract

Consequent upon the intermittent variations in the global oil prices over the years

and its attendant effects on exchange rate dynamics of oil-rich economies, the study

investigates the regime-switching behaviour of oil price shocks and exchange rate

behaviour in Nigeria. The period of investigation spans 1980q1 – 2020q4 and the

technique of analysis is the Markov-Switching Dynamic Regression. Predicated

on an extended portfolio balancing theory, the unit-root test with structural break

confirms break points in the data. The Markov-Switching Dynamic Regression

shows the presence of two regimes of low and high global oil price shocks in the

data. Additional results show that expectation plays a huge role in the oil price and

exchange rate nexus in Nigeria and that the regime of low global oil price comes

with more shock effects than that of high global price of oil. With short memory

property, both the low and high global prices of oil exhibit high persistence level

above 70 percent but the duration of persistence for the latter is half-life the former.

The study recommends that the monetary authority should introduce exchange rate

policy surprise and further diversify the economy from oil dependence.

ORIGINAL ARTICLE

Modelling oil price shocks and exchange rate behaviour in

Nigeria – A regime-switching approach

Taofeek Olusola Ayinde | Farouq Adekunmi Adeyemi | Busrah Agbaje Ali-Balogun

DOI: 10.1111/opec.12263

1 | INTRODUCTION

Economic fluctuations are an inherent feature of every economy. Every economy goes through the four phases of boom, peak,

contraction and trough. As a net oil exporter, Nigeria is bound to witness various components of shocks that affect both the

demand for and supply of oil from time to time. The determination of oil price is an exogenous variable beyond the reach of any

single player in the international market place. Precisely, no single oil-producing country can influence the optimal price level

that considers the interacting effects of demand for and supply of oil. Many issues, characterised as shocks, warrant the seem-

ingly unsystematic determination of oil price in the global market. The intervening variable that the shocks from oil pass to the

Nigerian economy is through its domestic currency, characterising different regimes and episodes of exchange rate in Nigeria.

It is highly instructive to note that between January 2003 and the third quarter of 2021, the global oil has witnessed four differ-

ent periods of shocks. These are the shocks from the global economic crisis of 2007–2009; the global oil glut of 2013–2015;

the global economic recession of 2016 and the COVID-19 global pandemic, which began in December 2019. The only period

of stability in global oil price occurred during the period 03/08/2011–6/19/2014 as it sold for above US$100 per barrel on the

average; despite little dips in few instances.

There are two periods of rise in global oil price. The first period of rising oil price is the most substantial, as oil price moved

up from US$30 to US$141. The second period of oil price rise is the least as oil price increased from US$74 to US$118 and

gravitates around US$100 to US120 per barrel during the period 03/08/2011–6/19/2014. Tension in the Middle East and the

© 2022 Organization of the Petroleum Exporting Countries.

wileyonlinelibrary.com/journal/opecOPEC Energy Rev. 2023;47:71–83. 71