The Role of Trade Openness and Oil Price on Exchange Rate: ARDL Bound Testing Evidence from Nigeria

Abstract

The nexus between oil price and exchange rate has been explored widely in the theoretical and empirical literatures revealing factors that influence exchange rate fluctuation. Therefore, this research examines the role of trade openness and oil price on the behaviour of exchange rate in Nigeria. We applied Autoregressive Distributed Lag (ARDL) bounds testing approach to cointegration based on annual time series data from 1982 to 2014. The variables are cointegrated indicating that they exhibit long run relationship. Also, the estimated value of the error correction term is less than one, negative but significant. Exchange rate was found to be negatively dependent on trade openness in both the short run and the long run, while oil price was found to be negative and insignificant in the long run. The policy implication of these findings is that high dependency on oil price is not favorable to exchange rate determination in Nigeria. There is need to diversify the source of foreign revenue especially to the non-oil sectors such as agriculture, mines and industry and manufacturing to reduce the extreme burden and the negative consequences of over dependence on oil and the volatility in its price on Nigeria’s economy.

Keywords: exchange rate, oil price, trade openness, error correction term