Estimating the effect of currency substitution on exchange rate volatility: Evidence from Ghana

Abstract

This paper investigates the impact of currency substitution on exchange rate volatility using monthly data from January 1990 to May 2019. The paper applies the exponential generalized autoregressive conditional heteroscedastic in mean (EGARCH-M) model as the estimation technique. The results reveal that currency substitution has a significant positive impact on exchange rate volatility. The paper also confirms the existence of leverage effects in the exchange rate volatility. It is also revealed that negative shocks are found to have greater effect than positive shocks. Furthermore, the results indicate that inflation targeting framework has a significant positive impact on exchange rate volatility. Based on the findings and discussion, the paper concludes that currency substitution increases exchange rate volatility in Ghana. Given the findings, vital policy implications aimed at reducing or eliminating volatility in exchange rate have been provided for policy consideration.

Keywords

• currency substitution
• exchange rate volatility
• inflation targeting
• EGARCH
• Ghana