Impact of oil prices on the exchange rate in Kenya

Abstract

The aim of this study is to estimate the impact of global oil prices on the exchange rate of Kenya for a monthly series from April 2000- April 2016. The modelling exercise follows 3 steps. In first step, the paper investigates the unit root test to check for stationarity in the individual variables. The second step is to run a diagnostic test to check for autocorrelation, normality and heteroscedasticity. In the third step, we estimate the equation for our model using OLS to determine its significance and the relationship between oil prices and exchange rate. The results are that oil price and exchange rate have an inverse relationship with the coefficient of oil having a negative sign. The paper goes ahead and runs GARCH test to get the conditional volatilities of exchange rate and oil price and after which a linear regression model was used estimate the relationship between the conditional volatilities of the two variables. The study then concludes that the conditional volatility between the two variables is significantly related. This implies that oil prices are a very vital variable in determining the strength of the currency and it’s volatility. The Kenyan Government should consider the impacts of oil prices when formulating and implementing economic policies, especially the exchange rate policies.