Forecasting of Exchange Rate Volatility between Naira and US Dollar Using GARCH Models

Abstract

Exchange rates are important financial problem that is receiving attention globally. This study investigated the volatility modeling of daily Dollar/Naira exchange rate using GARCH, GJR-GARCH, TGRACH and TS-GARCH models by using daily data over the period June 2000 to July 2011. The aim of the study is to determine volatility modeling of daily exchange rate between US (Dollar) and Nigeria (Naira). The results show that the GJR-GARCH and TGARCH models show the existence of statistically significant asymmetry effect. The forecasting ability is subsequently assessed using the symmetric lost functions which are the Mean Absolute Error (MAE), Root Mean Absolute Error (RMAE), Mean Absolute Percentage Error (MAPE) and Theil inequality Coefficient. The results show that TGARCH model provide the most accurate forecasts. This model will captured all the necessary stylize facts (common features) of financial data, such as persistent, volatility clustering and asymmetric effects. 1.0 Introduction Most research have been made on forecasting of financial and economic variables through the help of researchers in the last decades using series of fundamental and technical approaches yielding different results. The theory of forecasting exchange rate has been in existence for many centuries where different models yield different forecasting results either in the sample or out of sample. Exchange rate which means the exchange one currency for another price for which the currency of a country (Nigeria) can be exchanged for another country's currency say (dollar). A correct exchange rate do have important factors for the economic growth for most developed countries whereas a high volatility has been a major problem to economic of series of African countries like Nigeria. There are some factors which definitely affect or influences exchange rate like interest rate, inflation rate, trade balance, general state of economy, money supply and other similar macro – economic giants' variables. Many researchers have used multi-variate regression approach to study and to predict the exchange rate base on some of