Is the South African exchange rate volatile? Application of the arch framework

Abstract

This study applies the autoregressive conditional heteroscedasticity (ARCH) model to forecast exchange rate volatility in South Africa for the period 1990Q1 to 2014Q2. The ARCH (1) and ARCH (2) models were constructed using four variables; namely, exchange rate, gross domestic product, inflation and interest rates. Upon addressing the issue of stationarity, the models were fitted and the ARCH (1) model was found to be fit. This model revealed a high volatility of exchange rate compared to the ARCH (2) model. Prior to forecasting, the selected model was subjected to a battery of diagnostics tests and was found to be stable and well specified. The forecasts from the ARCH (1) model proved that in the near future, exchange rate will not be highly volatile though SA will experience depreciation in its currency.