Naira options pricing and exchange rate volatility in Nigeria

Godfrey Oke Omojefe; Anderson Emmanuel Oriakpono

doi:10.47494/mesb.v12i.538

(1) Godfrey Oke Omojefe University of Port Harcourt
Nigeria
(2) Anderson Emmanuel Oriakpono State University of Science and Technology
Nigeria
(*) Corresponding Author

DOI:

https://doi.org/10.47494/mesb.v12i.538

Keywords:

Naira Options Pricing, Exchange Rate Volatility, ARCH, EGARCH, Unit Root

Abstract

Volatility is the key ingredient for the pricing of assets and derivative securities. This study pursues this reasoning for the exchange rate conditions in Nigeria based on the Black and Sholes option pricing model. The effect of naira option pricing on the volatility of the naira exchange rate is investigated in the study. The implications of different pricing strategy of the naira across the official, interbank and Bureau de Change (BDC) markets are examined. In the empirical analysis, the role of risk-free rate, and the differentials in different market pricing of the naira were shown to have strong and significant impacts on exchange rate volatility in Nigeria. While risk-free rate was shown to be stabilizing in the market, the differentials between official and other market rates of the naira had strong exacerbating effects on the volatility of exchange rate. Thus, the study demonstrates that when there are diverse pricing options for the naira, the exchange rate tends to be highly unstable in Nigeria

Downloads

Download data is not yet available.

References

Andersen, T. G., Bollerslev, T., Diebold, F. X., and Labys, P. (2003). Modeling and forecasting realized volatility. Econometrica 71, 579-625.

Andersen, T. G., Bollerslev, T., Diebold, F. X., and Labys. P. (2001). The distribution of realized exchange rate volatility. Journal of American Statistical Association 96,42-55.

Black, F., and Scholes, M. (1973). The pricing of options and corporate liabilities. Journal of Political Economy 83, 637-705.

Bollerslev, T., Chou R. Y., and Kroner, K. F. (1992). ARCH modeling in finance: a review of the theory and empirical evidence. Journal of Econometrics 52, 5-59.

Budina, N ., Pang , G . & Wijnbergen ,V.S . (2007) . Nigeria’s Growth Record: Dutch Disease or Debt Overhang? World Bank Research Working Paper, 4256 .

Chibber, A . (1991). Africa’s Rising Inflation. Working Papers, WPS 577, World Bank.

Edwards, S . (1994). Real and Monetary Determinants of Real Exchange Rate Behaviour: Theory and Evidence from Developing countries, in: Williamson, J . (ed.): Estimating Equilibrium Exchange rates. Washington: Institute for International Economics.

Kemme, D . M . & Roy, S. (2006). Real exchange rate misalignment prelude to crisis. Economic Systems, 30(1) , 207-230 .

Manzur, M., Hoque, A. & Poitras, G. (2010). Currency Option Pricing and Realized Volatility.Banking and Finance Review, 73-85.

Merton, R. C. (1973). Theory of rational option pricing. The Bell Journal of Economics and Management Science 4, 141-183.

Pinto, B . , (1990) . Black market premia, Exchange rate unification and inflation in Sub-saharan africa ,The World Bank Economic Review , 3(3) , 321-338.

Sanusi, J. (2004). Nigeria’s Exchange rate mechanism: The current Experience. Being a Paper presented at Nigerian- British Chamber of commerce. Available from: http://www.cenbank.org/OUT/SPEECHES/2004/Govadd-24Feb.pdf

Xiaopu, Z. (2002). Equilibrum and misalignment: An assessment of the RMB exchange rate from 1999. Centre for research on Economic Development and Policy Reform, Working Paper No. 127.