Impact of exchange rate volatility on inflation rates in Kenya: GARCH model approach

Abstract

The purpose of this research is to find out the effect of exchange rate volatility on inflation rates in Kenya. The methodology involves the use of generalized autoregressive conditional heteroskedastic (GARCH) approach in modeling exchange rate volatility in Kenya and finding the effect it has on the inflation rate. The research applies both asymmetric and symmetric models that capture most common stylized facts about exchange rate returns such as volatility clustering and leverage effect. The period of focus is between 2005 and 2015 and the empirical results show that there is volatility clustering and that exchange rates have an impact on inflation rates. The study is valuable to the central bank of Kenya, research institutes, commercial banks and investment firms.