The Effect of political risk on exchange rate volatility: the case of Kenya

Abstract

The Kenyan economy, like many other economies in the world, is sensitive to the political events that occur. In modem day, economies with stable political environments and efficient economic policies have strong and healthy economies and are a big draw for investors. Stable exchange rates are an indicator of good economic performance. This paper examines the effect of political risk in Kenya on the volatility of exchange rates. It uses daily time series data of the Euro and USD exchange rates that covers a period from June 2007 to August 2013. The period covers three major political events; the 2007 general election, the 2010 constitutional referendum and the 2013 general election. This study uses a TGARCH(1,1) with a dummy variable for political risk. Results from the data analysis show that political risk has significant effects on the volatilities of the Euro and USD exchange rates. Recommendations on additional studies are made. First, a possible study can be done to investigate the effect of political risk on additional exchange rates e.g. the Japanese yen (JPY), the British pound (GBP), etc. Similarly, further research could be done to establish the effect of both positive and negative political shocks on Kenyan economy