Volatility Analysis of Exchange Rate of Emerging Economies: A Case of East African Countries (1990-2010)

Abstract

The aim of this study is to analyze the volatility of exchange rates of the currencies of the five East African Community (EAC) countries. Time series modeling is applied to the data of these countries. Various models were fitted and compared using Maximum Likelihood approach in order to select the best fitting model for each of these countries. The paper also aims at establishing whether NEWS affects the smooth movements of the exchange rates. Static and dynamic forecasts were obtained for periods of unrests to ascertain the contribution of the NEWS to abrupt shifts in the exchange rates movements. The results show that all the economies yield significant volatility models implying that the exchange rate volatility does exist in these countries. Furthermore, forecasts show that the exchange rate volatility in these countries reduce after the date of each one’s joining the EAC. This implies that openness of these economies should be encouraged to reduce the exchange rate volatilities of their currencies. The existence of high rates of exchange volatility could be explained by the fact that these currencies are not pegged to any major international currency. The countries are thus advised to peg their currency to avoid future fluctuations.