ON THE HEDGING CHARACTERISTICS OF GOLD AGAINST EXCHANGE RATE (NGN-USD) USING MARKOV APPROACH

Abstract

The removal of pegs on the exchange rate by the Central Bank of Nigeria has exposed the Nigerian currency (Naira) to a wobbly trend in recent times. A direct consequence of currency depreciation is the loss of wealth and purchasing power by those whose income and assets are in the devalued currency. One of the ways to safeguard against the possible losses is to hedge with commodity-related assets and other precious metals that have the potential to appreciate or at worst, remain stable during currency depreciation. This study investigated the impact of exchange rate (NGN-USD) on gold price using Markov chain modelling approach. A three-state Markov chain model which classified the state as Increase (I), Decrease (D) and Stable (S) was used to model the stochasticity of each of exchange rate (NGN-USD) and gold price (USD). Thereafter, the impact of exchange rate on gold price was examined using a three-state Markov Chain with classification: positive impact, negative impact, and no impact. The study considered daily time-series data of exchange rates and gold prices sourced from the Central Bank of Nigeria (CBN) and World Gold Council (WGC) bulletins, respectively from year 2001 to 2024. The long-run distribution of exchange rate (NGN-USD) was obtained as 13% for increase, 11% for decrease, and 76% for stable states, while the gold price has a long-run distribution of 51% for increase, 46% for decrease, and 3% for stable states. Further results revealed that exchange rate has a 7% positive impact, a 5% negative impact, and 88% no impact on gold price, with mean occurrence times of 15 days, 20 days, and 1 day respectively. The study established that investment in gold can serve as a hedge against exchange rate (USD-NGN) fluctuations.