Naira options pricing and exchange rate volatility in Nigeria
Keywords:
Naira Options Pricing, Exchange Rate Volatility, ARCH, EGARCH, Unit RootAbstract
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
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