Does Financial Deepening Matter in the Nexus between Exchange Rate Volatility and Foreign Investment? Insight from Nigeria

Abstract

This study empirically explores the role of financial deepening in the nexus between exchange rate volatility and foreign investment in Nigeria from 1986Q1 to 2020Q4 using the Autoregressive Distributed Lag Cointegration procedure. Our result shows that exchange rate volatility stimulates foreign investment in the short run while it reduces foreign investment in long run. However, the combined effect of financial deepening and exchange rate volatility shows that financial deepening helps to alleviate the adverse effect of volatile exchange rate in the long run. This study suggests that the depth of the financial sector matters in easing the adverse effect of exchange rate volatility on foreign investment in the long run. Therefore, policymakers are encouraged to further strengthen the financial sector by introducing appropriate regulations and reforms to broaden the depth of the financial sector in order to boost the confidence of foreign investors in the economy.