An Econometric Assessment of the Real Effective Exchange Rate Volatility in Kenya

Abstract

A country’s real effective exchange rate (REER) is an important determinant of the growth of cross-border trading and it serves as a measure of its international competitiveness. The REER is an active source of discussions in Kenya where questions have arisen revolving around persistent exchange rate shocks and possible interventions. Kenya’s vulnerability to the external shocks has increased and the real effective exchange rate has experienced episodes of appreciations. There is scanty information that has specifically focused on the Kenyan’s real effective exchange rate (REER). This study carried out an assessment of the real effective exchange rate (REER) volatility in Kenya. The study was guided by the Dornbusch overshooting model and adopted correlation Research Design. It relied on secondary data for the period 1972–2015. To overcome the methodological deficiencies of using the measures of unconditional volatility, this study focused on the conditional volatility employing the GARCH technique that is a superior measure of uncertainty. The Augmented Dickey-Fuller and Phillip-Perron approaches were used to test for the presence of unit roots. It was found that real effective exchange rate in Kenya has been volatile within the period under consideration. These findings will add value to the Dornbusch overshooting model, production flexibility and risk aversion theories and partial and general equilibrium theories and will further help in the formulation of fiscal and monetary policies to address macroeconomic shocks associated with REER shocks in the Kenyan economy.