Foreign Portfolio Investment Volatility and Exchange Rate Dynamics in Nigeria: An Empirical Investigation

This study empirically investigates the relationship between foreign portfolio investment (FPI) volatility and exchange rate dynamics in Nigeria, examining the extent to which sudden reversals in portfolio capital flows contribute to naira exchange rate instability. Nigeria's experience with stop-and-go portfolio capital inflows, driven by global monetary policy cycles and domestic macro-fiscal shocks, has repeatedly exposed the vulnerability of the naira to sudden capital flight. The research employs a quantitative design using quarterly time series data on FPI flows, exchange rates, foreign reserves, and interest rate differentials sourced from the Central Bank of Nigeria and the International Monetary Fund for the period 2010 to 2023. Vector Autoregression and Granger causality tests are applied to determine the directionality and magnitude of the FPI-exchange rate interaction, supplemented by impulse response analysis. The Generalised Autoregressive Conditional Heteroscedasticity model is used to model exchange rate volatility. The theoretical framework draws on the portfolio balance model of exchange rate determination and the sudden stop literature in international finance. Findings are expected to confirm that FPI outflow episodes precede significant naira depreciation events, with the impact being stronger during periods of low foreign reserve buffers. The study fills a gap in the literature by focusing specifically on the transmission mechanism from portfolio capital volatility to exchange rate outcomes in the Nigerian context. Policy recommendations include building counter-cyclical foreign reserve buffers, developing hedging instruments for naira exchange rate risk, and diversifying the foreign investor base toward longer-horizon institutional investors. Keywords: foreign portfolio investment, exchange rate, Nigeria, capital flows, GARCH