Journal of International Money and Finance

20 (2001) 987–1001
www.elsevier.com/locate/econbase

Distribution of parallel exchange rates in

African countries
a,* b
Hippolyte Fofack , John P. Nolan
a
The World Bank, 1818 H St., NW, Room J7-138, Washington, DC 20433, USA
b
American University, 4400 Massachussetts Ave, NW, Washington, DC 20016, USA

Abstract

This paper investigates the distribution of parallel exchange rates in African countries using
exploratory data analysis techniques and model fitting. Stable laws are fitted to empirical distri-
butions using the maximum likelihood estimation method. Empirical evidence supports the
stable hypothesis these distributions are positively skewed and have tails that are much heavier
than Gaussian counterparts. The stable hypothesis is further supported by the “converging
variance test,” which suggests that these distributions have infinite variance.  2001 Elsevier
Science Ltd. All rights reserved.

JEL Classification: C13; D30; F31

Keywords: Parallel exchange rates; Stable distributions; Heavy tails; Maximum likelihood estimation

1. Introduction

Studies that examine the distributions of foreign exchange rates have been prim-
arily concerned with changes observed in currencies of major trading nations, when
they are crossed against the United States dollar. While a large number of studies
have been devoted to analyzing the distribution of foreign exchange rate changes
for developed countries (McFarland et al., 1992; Calderon-Rossel and Ben-Horim,

* Corresponding author. Tel.: +1-202-473-6298; fax: +1-202-473-8466.

E-mail addresses: hfofack@worldbank.org (H. Fofack); jpnolan@american.edu (J. P. Nolan).

0261-5606/01/$ - see front matter  2001 Elsevier Science Ltd. All rights reserved.
PII: S 0 2 6 1 - 5 6 0 6 ( 0 1 ) 0 0 0 3 1 - 6
988 H. Fofack, J.P. Nolan / Journal of International Money and Finance 20 (2001) 987–1001

1982; McCulloch, 1987; Rachev, 1995; Nolan, 2001)1, very little attention has been
given to the same issue for currencies of developing countries. One of the few studies
which investigates the distributional properties of foreign exchange rate changes in
developing countries focuses on Latin American countries and is essentially con-
cerned with the distribution of parallel exchange rate changes (Akgiray et al., 1988).
The lack of research on foreign exchange rates for currency markets in developing
countries is even more evidenced by the absence of studies on foreign exchange rate
for African currencies. Nowhere in the literature is there a clear account, of exchange
rate fluctuations in African countries. This paper focuses on the distribution of paral-
lel exchange rates in African countries.
Parallel currency markets are widespread in African countries where official and
parallel exchange rates coexist and are used interchangeably in commercial and capi-
tal transactions (for a general overview of the theory of parallel currencies markets
see Agénor 1991, 1992). The existence of such markets has important economic and
welfare implications, and their scope may be more important in countries which are
confronted with high inflation, or where the official exchange rate is used as a policy
instrument. In high inflation economies with increased uncertainty, these markets
may reflect increasing need for portfolio diversification, because foreign currency
holding represents an efficient hedge against domestic inflation.2 Despite the scope
of these markets and evidence that inferences on economic fundamentals are sensitive
to the distributional assumptions (Bidarkota and McCulloch, 1996), not much atten-
tion has been devoted to fluctuations recorded in these markets and their distri-
butional properties remain unknown.
This study investigates the distributional properties of parallel exchange rate
changes in African currency markets. Stable laws are fitted to parallel exchange rate
changes using the maximum likelihood estimation method. Empirical findings reveal
the prominence of large fluctuations in these markets, and suggest that non-Gaussian
stable models describe these exchange rate movements better than Gaussian models
which are less appropriate for leptokurtic distributions with asymmetric shape.
Past studies which have considered stable distributions as approximating models
for fluctuations of foreign exchange rate have used either the fractile method range
(Fama and Roll, 1971; McCulloch, 1986; Czarnecki, 1994), or the sample character-
istic function method (Akgiray et al., 1988; Mittnik and Rachev, 1993) to estimate
the distribution parameters. This paper estimates the distribution’s parameters by
maximizing the likelihood function. The fractile range method uses few sample quan-
tiles and not the entire spectrum of the distribution. The derived parameter estimates
are likely to be sensitive to variation of the sample quantiles. In contrast, maximum
likelihood estimates are based on the full data set and are uniformly minimum vari-

1
These studies focus on foreign exchange rate changes in spot markets, and the distributional properties
of changes observed in these markets. The studies find that the underlying distributions are asymmetric
and non-Gaussians.
2
The welfare implications of these markets are much broader however; they have potential for raising
employment through increased domestic availability of imported goods (McDermott, 1989).
 H. Fofack, J.P. Nolan / Journal of International Money and Finance 20 (2001) 987–1001 989

ance unbiased (UMVU) estimates. One would therefore expect these estimates,
which are asymptotically efficient, to be more accurate.
The remainder of the paper is organized as follows. The next section provides a
description of the data set. Section 3 describes statistical models and estimation pro-
cedures. Stable laws are fitted to exchange rate data followed by some discussion
of economic implications in Section 4. Diagnostics and the rationale for model selec-
tion are provided in Section 5, followed by concluding remarks in Section 6.

2. Parallel exchange rate data

The data set consists of foreign exchange rates for 14 countries, recorded monthly
at end-of-period over 22 years, starting January 1975 and ending September 1997.
Local currencies are crossed against the United States dollar and exchange rate values
represent the price in local currency of a US dollar at market rate recorded over
consecutive months, for the following countries—currencies: (1) Ethiopia, Birr; (2)
Ghana, Cedi; (3) Guinea, Franc Guineen; (4) Kenya, Shilling; (5) Libya, Dinar; (6)
Malawi, Kwacha; (7) Morroco, Dirham; (8) Nigeria, Naira; (9) South Africa, Rand;
(10) Tanzania, Shilling; (11) Tunisia, Dinar; (12) Uganda, Shilling; (13) Zambia,
Kwacha; (14) Zimbabwe, Dollar.3 Official exchange rate series are obtained from
the International Monetary Fund’s International Financial Statistics (IFS). Parallel
exchange rate data are obtained from Currency Data and Intelligence, Inc., World
Currency Yearbook and Global Currency Report.
Analysis of these time series shows an increasing trend with persistent gap
between official and parallel exchange rates.4 This increasing trend suggests that
most African currencies depreciated against the US dollar over the period of analysis.
However, the rate of depreciation was not uniform over time. Fig. 1 which provides
the time plot of parallel and official exchange rate for the Morrocan Dirham against
US dollar shows that depreciation was particularly high between 1980 and 1984—
the price of a dollar in local currency increased from 4 to 10 Dirham. Since 1985,
depreciation has been less systematic and instances of depreciation have been fol-
lowed by phases of appreciation. Moreover, foreign exchange rate movements have
been confined within a relatively small bandwidth.5
Fluctuations are frequent and important in parallel currency markets. Parallel rates

3
Multiple exchange rate regimes were used in some of these countries during the period of analysis:
flexible and fixed exchange rate; for instance Ghana moved from fixed to floating mechanism in the mid-
eighties, and Guinea moved from flexible to fixed exchange regimes in the nineties—when the Guinean
Franc became part of the WA Franc monetary union.
4
The presence of a persistent gap between official and parallel exchange rate changes, where the sign
of covariation is often the same suggests some form of dependency between these distributions.
5
Probably, changes in the rate of depreciation reflect recent monetary arrangements where the
exchange rate is maintained within margins of ±3 percent (for more details on recent exchange rates
arrangements in developing countries see Caramazza and Aziz, 1998).
990 H. Fofack, J.P. Nolan / Journal of International Money and Finance 20 (2001) 987–1001

Fig. 1. Time plot of parallel and official rate for fluctuation of the Moroccan Dirham against the US
dollar (in months since 1/75).

are often higher than official rates.6 Exchange rate differentials between the official
and parallel exchange rates, where the latter is consistently much higher, are partly
due to the fact that parallel markets for foreign exchange tend to react, more swiftly
to changes in economic fundamentals, but also because exchange restrictions in the
official markets relate to purchases of foreign currency and not to sales.7 More
specifically, for the time series representing fluctuations in currency markets, if F(y),
H(y) are cumulative distribution functions associated with parallel and official
exchange rates, respectively, then F(y)⬍H(y) for large y.
This paper models the noise and not the drift terms. The time series have been
transformed to remove the trend components. Approximate stationarity is achieved
by applying a logarithmic transformation to the ratio of these series. Parallel
exchange rate changes are now defined as the natural logarithm of the ratio of two
successive monthly rates: if Yt is the monthly rate recorded on the parallel market
then the transformed series is represented by Yt⬘ = ln(Yt + 1/Yt). In the remainder of
this paper, the data analysis and estimation procedures are based on these transformed
series. Relevant characteristics of these distributions are provided by Figs. 2 and 3.
Fig. 2 shows the time plot of transformed parallel exchange rate changes for the
Moroccan Dirham against the US dollar. Fig. 3 shows the histogram of the same
distribution with the fitted normal density superimposed on it. These distributions
are characterized by frequent occurences of sharp spikes and bursts of outlying obser-
vations. The variations in the frequency distribution occur more often than what one
would normally expect from data generated from Gaussian model. It is possible that

6
Differences in level of fluctuations between official and parallel exchange rate changes are reflected
in parallel markets premium which at time can be particularly high, especially when the official rate is
adjusted with time lag.
7
Consistently higher rates in black markets suggests a positive premium; however, negative premia
may occur in periods of excess supply in parallel markets, when expectations of revaluation of the official
currency are high, or when commercial bank’s transactions on foreign currencies are subject to
exchange controls.
 H. Fofack, J.P. Nolan / Journal of International Money and Finance 20 (2001) 987–1001 991

Fig. 2. Time plot of parallel exchange rate changes of the Moroccan Dirham against the US dollar,
transformed (in months since 1/75).

Fig. 3. Distribution of parallel exchange rate changes for fluctuation of the Moroccan Dirham against
the US dollar with normal density N(X̄, S2) superimposed.

these large deviations from the mean occur when parallel exchange rates overreact
to changes in economic fundamentals or in anticipation of adjustment of the
official rates.
In addition to sharp spikes, the distribution of parallel exchange rate changes are
asymmetric and have more probability mass in the tails. In fact the coefficient of
skewness is highly positive, so that P(Yt⬍⫺l)⬍P(Yt⬎l) for large l. Similarly, these
distributions have continuous support and are unimodal. The mode occurs around
zero in the transformed scale. These represent points where no change is recorded
in foreign exchange rates between consecutive months, or points where changes over
consecutive months are relatively small. These graphs represent the Moroccan
Dirham, but a similar pattern is observed for currency movements recorded in
other countries.
992 H. Fofack, J.P. Nolan / Journal of International Money and Finance 20 (2001) 987–1001

3. Stable distributions and parameter estimation

The probability densities of stable random variables exist and are continuous but,
with few exceptions (Gaussian, Cauchy, Lévy), they are not known in closed form.
As a result, stable distributions are often represented by their characteristic functions.
The most popular representation is the S parameterization defined by (Samorodnitsky
and Taqqu, 1994). However, for numerical purpose, it is preferable to use the S0
parameterization: we will say X0苲S0a(s, b, m0) if the characteristic function of X0 is
given by
E exp(iqX0)

冉 冉 冊
ap
冊
冦
exp[⫺sa|q|a 1 ⫹ ib tan sign(q)((s|q|)1⫺a⫺1) ⫹ im0q] if a⫽1
2

冉 冊
⫽ ,
2
exp[⫺s|q| 1 ⫹ ib sign(q) ln|sq| ⫹ im0q] if a ⫽ 1
p

where

冦
1 q⬎0
sign(q) ⫽ 0 q⫽0
⫺1 q⬍0.

The S0 parameterization is a variant of the (M) parameterization of Zolotarev

(1986), with the characteristic function jointly continuous in all four parameters (for
more details on representation of stable distribution in the S0 parameterization see
Nolan, 1998). In particular, modes, percentiles and hence the density and the distri-
bution function are jointly continuous in all four parameters. Moreover, modes, per-
centiles and convergence to Paretian tail behavior vary in a continuous way as a
and b vary (Fofack, 1998; Fofack and Nolan, 1999).
The distributions of one-dimensional stable random variables are described by four
parameters (a, s, b, m). We will denote the a-stable distribution by S0a(s, b, m0) and
write X苲S0a(s, b, m0) to indicate that X has an a-stable distribution with parameters
(s, b, m0). The parameter a苸(0,2] is the index of stability or characteristic exponent,
sⱖ0 is the scale parameter, m0苸R is a shift parameter and b苸[⫺1,1] is a skewness
parameter. The stable index defines the fatness of the tails and may be interpreted
as the tail shape parameter. This parameter is particularly important for model fitting.
Non-Gaussian stable tails probabilities are proportional to x⫺a and the lower the
value of a, the thicker the extreme tails of the distribution. Symmetric stable corre-
sponds to b=0. The distribution is skewed to the right when b⬎0 and skewed to the
left when b⬍0. When a=2, the distribution is normal, when (a=1, b=0), the stable
 H. Fofack, J.P. Nolan / Journal of International Money and Finance 20 (2001) 987–1001 993

distribution is symmetrical and corresponds to the Cauchy. The parameters a, b, and

s have the same meaning in both the S and S0 parameterization, while the location
parameters of the two representations are related by m = m0⫺

冉 冊
b tan
ap
2
2
s if a⫽1; m = m0⫺b s ln s when α=1.8
p
Stable distributions have theoretical properties which make them extremely
appealing for statistical and economic modeling.9 These distributions are extremely
flexible and because of their skewness parameter, can be used to model symmetric
and asymmetric distributions. The range of the characteristic exponent allows for
infinite variance (0⬍a⬍2), and infinite mean (0⬍aⱕ1). The infinite variance
assumption is often used to characterize distributions which are dominated by one
or few observations.

3.1. Methods of estimation

→
Let q = (q1, q2, q3, q4) = (a, b, s, m0) be the vector of stable parameters, and
→
f(x|q ) the stable density function. The parameters space is ⌰ = (0,2]×
[⫺1,1]×(0,⬁)×(⫺⬁,⬁). The parameter estimates are derived by maximizing the natu-
ral logarithm of the likelihood function

冘
n
→ →
l(q ) ⫽ log f(Xi|q ).
i⫽1

The maximization is achieved by a gradient based search. DuMouchel (1971,

→
1973) shows that when q 0 is in the interior of the parameter space ⌰, the maximum
likelihood estimates follow the standard theory and is asymptotically normal with
→
mean q 0 and covariance matrix given by n⫺1⌫, where ⌫ is the inverse of the Fisher
→
information matrix I, associated with the vector of parameters q . I is a 4×4 matrix
with entries specified by

Ii,j ⫽ 冕⬁

⫺⬁
∂f ∂f 1
∂q i ∂qj f
dx.

Nolan (2001) computed the Fisher information matrix for a grid 0.5ⱕaⱕ2 and
for 0ⱕbⱕ1, large sample confidence intervals for the parameters are given by

8
Unlike the S parameterization, S0 is a scale and location family of distributions: if Y苲S0a(s, b, m0),
then for any a, b, aY + b苲S0a(|a|s,(sign a)b, am0 + b).
9
For more details on the properties of one-dimensional stable distributions, see Zolotarev (1986),
Samorodnitsky and Taqqu (1994) and Rachev and Mittnik (2000).
994 H. Fofack, J.P. Nolan / Journal of International Money and Finance 20 (2001) 987–1001

sq̂i
q̂i±za/2 , where sq̂1,…,sq̂4 are the square roots of the diagonal entries of I (for more
√n
details on the generalized maximum likelihood estimation procedure and tabulation
of I see Nolan, 2001).

4. Results and empirical findings

The authors fitted stable distributions to the parallel exchange rate changes data
to estimate the parameters and standard errors of a and b for these empirical distri-
butions. Since we are focusing on the shape and leptokurtosis, inference is drawn
on these distribution by looking at the tail index estimate â and the skewness para-
meter b̂. Table 1 provides parameter estimates along with the 95% confidence inter-
vals for the tail index and skewness parameter.10 The tail index estimates are signifi-
sâi
cantly different from 2—i.e., âi + za/2 ⬍2, and none of the confidence intervals
√n
includes 2, implying that, these distributions have heavy tails. The most heavy tailed
distributions are the Ethiopian Birr (â = 0.8645), the Ghana Cedi (â = 0.9099), the
Zambian Kwacha (â = 0.9422) and the Tanzanian Shilling (â = 1.0885); while the

Table 1
Parameter estimates of stable law S0a(s, b, m0), approximating model for exchange rate fluctuations in
parallel markets

Country Stable parameter estimates

â b̂ ŝ m̂0

Ethiopia 0.8645±0.118 0.0870±0.184 0.01576 0.001513

Ghana 0.9099±0.145 0.1747±0.195 0.017459 0.010105
Guinea 1.0066±0.155 0.0670±0.211 0.014589 0.00458
Kenya 1.4921±0.184 0.3702±0.332 0.02899 ⫺0.000607
Libya 1.234±0.172 0.1550±0.237 0.02807 0.00382
Malawi 1.4596±0.183 0.3970±0.142 0.02865 ⫺0.00196
Morocco 1.4378±0.186 ⫺0.0030±0.318 0.01919 0.00197
Nigeria 1.3648±0.178 0.4835±0.280 0.04841 ⫺0.00279
South Africa 1.3835±0.186 0.0944±0.309 0.3970 0.004011
Tanzania 1.088±0.185 0.1118±0.191 0.03003 0.0050057
Tunisia 1.4994±0.160 0.1655±0.332 0.02849 0.001564
Uganda 1.1403±0.163 0.2480±0.208 0.03534 0.00865
Zambia 0.9422±0.142 0.2648±0.178 0.0298 0.002746
Zimbabwe 1.2002±0.171 0.2363±0.225 0.03968 0.0067

10
While the present study is conducted on an initial sample of 272 observations, the parameters esti-
mates corresponding to fluctuations of the Ghana Cedi are based on a smaller sample of 212 because of
a gap in the time series between March and August 1979.
 H. Fofack, J.P. Nolan / Journal of International Money and Finance 20 (2001) 987–1001 995

ones which have the least heavy tails are the Kenyan Shilling (â = 1.492), and the
Tunisian Dinar (â = 1.499). It is notable that even “least heavy tailed” distributions
still fall within the domain of attraction of a non-Gaussian stable because they have
a characteristic exponent which is significantly less than 2. The lowest value of â
is (â⬎0.70), and even accounting for the confidence width, the lower end of the
confidence intervals remains consistent with results obtained in previous studies.11
Any model fitted to any data will produce some parameter estimates. However,
the validity of a model depends on its ability to approximate the empirical density
function and model the tail behavior for a random variable that is believed to have
been generated from a stable family. Hence, we supplement maximum likelihood
estimates by exploratory data analysis techniques: stabilized probability plots and
approximated densities. The stabilized probability plot is used instead of the standard
p–p plot to investigate the tail behavior of these distributions because stabilized p–
p plots give a better comparison (Michael, 1983).12 The distribution corresponding
to changes in the Tanzania Shilling has heavy tails and the distribution corresponding
to changes in the Tunisian Dinar has less heavy tails. This contrast provides further
insights on the implications of tail heaviness on the distributional shape. Fig. 4 shows
the stabilized probability plot and empirical density function for the Tanzanian Shil-
ling. This figure shows that the distribution of parallel exchange rate changes is
unimodal and highly leptokurtic. The stabilized probability plot, of data versus theor-
etical stable distribution S0a(s, b, m0) lies along the 45° line. This is an indication
that, these distributions have tails that are heavier than the normal distribution. The
stabilized probability plot of data versus theoretical stable shows a good match—it is
straight line, with no obvious curvature at the upper and lower end of the distribution.
In contrast, the Gaussian model produces a very poor fit, compared to the non-
Gaussian stable in approximating the empirical density. Indeed, the characteristic
exponent estimate â is relatively small and the tails of the distribution are long.
Extreme observations cause a large sample variance which explains the poorness of
the normal approximation to this distribution.
Fig. 5 provides the probability plot, graphs of stable fit, density approximation of
parallel exchange rate changes relative to the Tunisian Dinar—which is a distribution
with less heavy tails.
The tail index for the distribution of the Tanzanian Shilling is relatively small,
while (â = 1.0885), the tail index estimate for the distribution of the Tunisian Dinar
is much higher, (â = 1.499). This explains the slight improvement of the normal

11
In fact, estimates of tail index for monthly observations are confined between (0.5⬍a⬍2) in the
study by Akgiray et al. (1988), concerning the distribution of parallel exchange rate changes in Latin
American countries, and studies by Fama (1965) and Nolan (2001) concerning the distribution of official
exchange rate changes for developed countries.
12
In fact heavy tail data have little variation around the mode and much in the tails. In order to
reduce the effects of inflated variance in the extremes, Michael (1983), proposed applying the arcsine
transformation to the data to adjust the standard p–p plot so that the variance is uniform over the support
of the distribution. In practice, the standard p–p plot is constructed by plotting each transform
ui = F0{(yi⫺m)/s} vs. ti = (i⫺0.5)/n, the probability integral transform1
applied to the data
1
produces a
stabilized probability plot which is based on (2/p) arcsin[{(i⫺0.5)/n}2] and (2/p) arcsin[F20(yi⫺m)/s].
996 H. Fofack, J.P. Nolan / Journal of International Money and Finance 20 (2001) 987–1001

Fig. 4. Stabilized probability plot of data vs. stable fit (left) and smoothed data, normal fit and
S0a(s, b, m0) stable approximation of the distribution of parallel exchange rate changes (right) relative to
fluctuations of the Tanzanian Shilling (â = 1.0885).

Fig. 5. Stabilized probability plot of data vs. stable fit (left) and smoothed data, normal fit and
S0a(s, b, m0) stable approximation of the distribution of parallel exchange rate changes (right) relative to
fluctuations of the Tunisian Dinar (â = 1.4994).
 H. Fofack, J.P. Nolan / Journal of International Money and Finance 20 (2001) 987–1001 997

approximation which, however, is still inferior to the non-Gaussian stable competitor.

An improvement is observed around the mode, where the normal distribution does
relatively well; but in the tails, the normal does a poor job in approximating the
empirical distribution of foreign exchange rate changes. The extreme tails of the
normal approximation die off very fast, while the tails of the empirical distributions
are rather long.

4.1. Discussion and economic implications

The existence of heavy tails for distributions of parallel exchange rate changes in
African countries has several policy implications. Measures of risk are evaluated
under a hypothesis of finite variance in portfolio optimization theory when hedge
operations are considered against foreign exchange risks. When a⬍2, the variance
is infinite and measures of risk which are based on the second moment are no longer
appropriate. Measures of risk for non-Gaussian stable portfolios were proposed by
Press (1972), and McCulloch (1987). However, these measures are based on the non-
Gaussian stable scale parameters which are not yet embedded in portfolios theory,
despite evidence that attempts to reduce risk through portfolios diversification may
be counterproductive when the characteristic exponent is less than 2 (Fama, 1965;
McCulloch, 1987). Moreover, when a⬍1, the first moment of the distribution is not
even defined, and it becomes formally impossible to evaluate expected returns on
spot, and forward operations in parallel currency markets.
The stable parameter estimates and the density approximation for parallel
exchange rate changes show that these distributions are generally positively skewed,
and exhibit large fluctuations which cause future rates to deviate markedly from
previous rates. Positive skewness indicates a long-run tendency towards depreciation
of these currencies against the US Dollar which appears in the denominator. The
long-run tendency towards depreciation of these currencies and heavy tails character-
istic of these distributions are a reflection of persistency in shocks where the costs
of misguided policies persist much longer than what one would expect, in the normal
models where the distributions are symmetric with much lighter tails.
The determinants of equilibrium exchange rates include real interest rates, capital
controls, current account deficits and inflation. While most of these countries are
running a current account deficit, one should expect variation in the long-term move-
ments of these currencies against the US dollar to follow inflation differentials
between these countries and their trading partners. Instead, one observes a uniform
tendency towards a long-run depreciation of these currencies against the US dollar—
skewness parameters are positive (b⬎0) across all countries in the sample. The long-
run tendency towards depreciation of the foreign exchange points to fundamental
macro-economic disequilibrium with inflationary pressures and budget deficit, which
are likely to affect the level of competitiveness of these economies if the terms of
trade remain unchanged. Moreover, currency depreciation increases the real burden
(in domestic currency) of international debt, that is denominated in US dollars.
998 H. Fofack, J.P. Nolan / Journal of International Money and Finance 20 (2001) 987–1001

5. Testing for infinite variance

A comparison of empirical distributions to theoretical Gaussian quantiles provides

the basis for rejecting the Gaussian hypothesis. A non-Gaussian stable alternative is
not necessarily true because there are heavy tail distributions that are not non-Gaus-
sian stable.13 DuMouchel (1983) proposed to estimate the tail behavior by fitting the
Generalized Pareto distribution F(x) = 1⫺(1 + gx/s)⫺1/g to sub-sample of extreme
observations, because non-Gaussian stable tails are asymptotically Paretian (Lévy,
1925; Samorodnitsky and Taqqu, 1994).14
However, Akgiray et al. (1988) applied this test to exchange rate data and found
that the results were not conclusive. In fact, while non-Gaussian stable distributions
may have tails that are asymptotically Paretian, the point where the asymptotic power
behavior occurs is a complicated function of the parameters, and estimates based on
extreme values can be misleading (Fofack, 1998; Fofack and Nolan, 1999). Another
criteria for assessing the stability hypothesis is testing for infinite variance: non-
Gaussian stable random variables have unbounded support, and infinite variance.
When (a⬍2), stable distributions have infinite variance (Samorodnitsky and
Taqqu, 1994), and the “converging variance test” proposed by (Granger and Orr,
1972; Nikias and Shao, 1995) can be used for testing the stable hypothesis. For a
random variable Xt with infinite variance the sequence of sample variance S2n based
on first n observations does not converge. More specifically, let, xt, t = 1,2,…,N be
an iid sample from the same distribution. Take nⱕN⬍⬁ and x̄n as the mean of the
first n observations in the series. Let S2n is the sequence of sample variances defined

冘
n

as S2n = (xt⫺x̄n)2/n, for tⱕnⱕN. If the distribution has finite variance, then there
t=1
exists a finite constant, c⬍⬁ such that,

冘
n
a.s
(xt⫺x̄n)2/n →c as n→⬁.
t⫽1

In contrast, if the series is generated from a non-Gaussian stable distribution, this

quantity does not converge.15 The converging variance test is applied to distribution

13
Examples of such distributions include the Pareto distribution and variation of this family which
have density expressed as f(x) = c/(1 + |x|p), or f(x) = c/(1 + x2)p, where p is a power and c is a multiplicat-
ive constant.
14
The tail index, characteristics of extreme tail behavior is estimated from the Generalized Pareto
distribution, as the inverse of g—i.e. â⯝1/ĝ.
15
For more details on the “converging variance test” and its applications, see Granger and Orr (1972)
and Fofack (1998). Fofack (1998) applied this test to simulated distributions with finite variance: (standard
Gaussian (X苲N(0,1))) and (gamma (X苲G(a,b))); and infinite variance: (Cauchy distribution (
X苲S01(s, 0, m0))) and totally skewed stable distribution (X苲S01.2(s, 1, m0)). While the sequence of variances
associated with the first set of distributions converges rapidly, the variance of the latter set of distributions
oscillates with jumps as n increases.
 H. Fofack, J.P. Nolan / Journal of International Money and Finance 20 (2001) 987–1001 999

of parallel exchange rate changes for fluctuations of the Kenyan Shillings and Moroc-
can Dirham. The results are provided by Fig. 6.
The sample variances associated with these distributions do not converge—they
oscillate with frequent jumps as n increases. This supports the claim that the distri-
butions of parallel exchange rate changes have infinite variance.

6. Conclusion

This study analyzes the distributional properties of parallel exchange rate changes
in African countries. Stable laws were fitted to distributions of parallel exchange
rate changes by maximum likelihood methods. Confidence intervals for the para-
meters were constructed from the Fisher information matrix. Density approximation,
infinite variance test and test for tails heaviness are applied to parallel exchange rate
data to assess the stability hypothesis.
Parameter estimates and empirical tests support the stable hypothesis—the tail
index estimate is significantly less than two (a⬍2), and the skewness parameter is
positive (b⬎0). Distributions of parallel exchange rate changes for currency move-
ments in African countries are better described by positively skewed non Gaussian
stable distributions than by Gaussian ones.
However, while the shape of these empirical distributions appears to satisfy the
stable hypothesis, countries show a great variation in the magnitude of probability
in the tails. Invariably, these distributions have infinite variances, and for few coun-
tries, the mean cannot even be defined (Ethiopia, Ghana and Zambia). These vari-

Fig. 6. Asymptotic variances parallel exchange rate changes for Moroccan Dirham (left) and Kenyan
Shillings (right).
1000 H. Fofack, J.P. Nolan / Journal of International Money and Finance 20 (2001) 987–1001

ations in the shape of the distribution might be explained in part by divergences in

economic policies, exchange rate management, the scope of parallel markets, the
degree of exchange restrictions, the dependence structure between official and paral-
lel exchange rate changes in a dual exchange regime. For instance, expected changes
in official exchange rates may prompt overshooting of parallel market rates when
official and parallel rates are positively associated. It is likely that changes in the
parallel market rate in anticipation of official exchange rate adjustments are influ-
enced by the strength of the association and the direction of causality between the
two rates.
Several studies investigate the causality between official and parallel exchange
rates in dual exchange regimes (Kharas and Pinto, 1989; Akgiray et al., 1989; Agénor
and Taylor, 1993). Using Granger-Causality test, Agénor and Taylor find no consist-
ent causality pattern between official and parallel exchange rates for a sample of 19
countries. One potential problem with these studies is that the standard Granger-
Causality test assumes finite variance. However, if the transformed series do not
have finite variance, then the parameter estimates in the Granger-Causality test by
VAR will be unreliable.16 Future research will involve investigating the dependency
structure between official and parallel exchange rates under infinite variance assump-
tions.

Acknowledgements

This study relies on the World Currency Yearbook and Global Currency Report
for parallel exchange rates. The authors are grateful to Pierre-Richard Agénor for
discussions and helpful comments. They would like to thank the anonymous referees
for useful comments.

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