Modeling Returns and Volatility Transmission from Crude Oil Prices to Leone-US Dollar Exchange Rate in Sierra Leone: A GARCH Approach with Structural Breaks
This paper sought to shed
light on the impact of shocks to global oil prices on the Leone/US Dollar
exchange rate in Sierra Leone during the post war period spanning 2002M6 to 2020M5. To achieve this, the paper employed the GARCH family models with structural
breaks. After establishing the existence of ARCH effects and ensuring
stationarity of the data set, the paper first applied both GARCH (1,1) and GARCH (1,1) in Mean models to capture the symmetry effect of
global oil prices increase on exchange rate. Furthermore, the paper employed
exponential GARCH (EGARCH (1,1)) model to capture the asymmetric impact of
oil price increase on the Leone/US Dollar exchange rate. Amongthe three models estimated, the EGARCH (1,1) model was found to have the best fit as all of
its mean and variance coefficients were not only found to be statistically
significant but also had the least values of the model selection criteria. The empirical results suggest that an
increase in oil price leads to depreciation of the exchanges rate in Sierra
Leone and that exchange rate volatility
exhibits persistence and autoregressive behavior.
Furthermore, the paper finds evidence of asymmetry,
indicating that positive shocks to crude oil prices will lead to a higher
volatility in the exchange rate than negative shocks of the same magnitude. Finally, the paper finds evidence of
structural breaks in the exchange series. The main policy implication from
these findings is that the monetary authority should consider global oil
price dynamics and the past history of exchange rate movements when formulating
policy responses to exchange rate volatility in Sierra Leone.
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