Financial Stress and Exchange Rate Volatility in Sub-Saharan Africa: Evidence from New Datasets

This study utilizes a newly constructed index for financial stress to examine its predictive value for exchange rate volatility in sub-Saharan Africa (SSA). Using a methodology that accounts for the key features of the predictive model, we find that financial stress significantly and positively affects exchange rate volatility in SSA. This indicates that increased financial stress is linked to higher levels of exchange rate volatility in the region. Robustness checks conducted on Latin America and OECD countries show that financial stress generally elevates exchange rate volatility in developing countries, while the effect is less pronounced in emerging economies. Also, additional analysis conducted to examine the influence of exogenous shocks, such as oil shocks, shows that oil price changes amplify exchange-rate volatility in SSA, while the contrast holds for the emerging and other developing economies outside the SSA. These findings support the theory of financial contagion and purchasing power parity (PPP) in SSA. In light of these findings, policymakers in sub-Saharan Africa should prioritize enhancing financial system stability and shock-absorption mechanisms to better protect against external shocks.