Determination of optimal level of foreign reserves in Nigeria

This study adopts the "buffer stock model" advanced by Frenkel and Jovanovic (1981) to estimate the optimal level of foreign reserves for Nigeria. The Autoregressive Distributed Lag Approach (ARDL) was used to estimate the optimal foreign reserves function. The results show that the Nigeria's optimal reserves level responses to adjustment cost of holding reserves and exchange rate volatility and that importand opportunity cost of reserves holding have insignificant impact on Nigeria's optimal foreign reserves. The short run and long run estimates of the buffer stock model support the theory that foreign reserves holding in Nigeria is more sensitive to the precautionary than mercantilist motives of holding reserves. Thus, it is recommended that the Central Bank of Nigeria (CBN) should implement effective foreign reserves policies that consider exchange rate volatility, oil price volatility and global macroeconomic imbalances.