AN EMPIRICAL STUDY OF THE FOREIGN EXCHANGE RATE PREMIUM IN NIGERIA (1970-2007).

AN EMPIRICAL STUDY OF THE FOREIGN EXCHANGE RATE PREMIUM IN NIGERIA (1970-2007).

ABSTRACT

This work evaluates the trends in the parallel market exchange rate premium, its determination and impact on the foreign exchange market in Nigeria. It examines the impact of existing demand and supply gaps in the overall foreign exchange market on the determination of the parallel market premium. It further examines the impact of the parallel market exchange rate premium on the determination of the official exchange rate and the parallel market rates. The study uses the stock-flow model of Kiguel and O’connel (1994) to examine the impact of the parallel market exchange rate premium on the determination of the official exchange rate and the parallel market exchange rate. The estimation results reveal that the parallel market exchange rate premium has a significant negative effect on parallel market exchange rate in Nigeria. Thus, an increase in the foreign exchange rate premium tends to reduce the next round of parallel market exchange rate. On the other hand, the parallel market exchange rate premium affects the official exchange rate positively. This is because a high premium on the parallel market exchrange rate tends to increase the demand for foreign exchange at the official rate. The examination of the impact of the demand and supply gaps in the foreign exchange market shows that the coefficient of exchange rate imbalance can be negative or positive depending on whether there is excess demand or supply condition in the market.