Determination of the Kenya shilling real exchange rate volatility

Abstract

This study focuses on the Kenya Shilling (KSH) real exchange rate volatility over the period 1980: 1/ 1991:3. The prime objective is to formulate and estimate an econometric model that could capture the underlying data generation process of the KSH real exchange rate. An integrated Towe-Onis and Ozmucur . model is formulated and econometrically estimated using Two Stage Least Squires (2SLS) in the PC-GIVE computer package. The empirical results thereof lead us to conclude that the KSH real exchange- rate volatility cannot be ascribed entirely to exchange rate market fundamentals but also to foreign exchange market psychology. Consequently, we suggest that any attempt to defend the KSH real exchange rate from undue misalignment entails a policy mix that should include both indirect and direct remedial policy measures. The empirical results are also suggestive of the existence of a negative median in the excess rate of return on three month forward contracts denominated in domestic currency. That could partly explain observed asset portfolio adjustrnents effected by some international trade agents; presumably, in their effort to realize sound currency exposure management