Decoding Egypt's Exchange Rate Puzzle: Forecasting Official and Unofficial Market Trends with Advanced Models

Purpose: This paper investigates, for the first time, the dynamics of Egypt’s unofficial exchange rate alongside the official rate, a critical issue for investment decisions and macroeconomic stability. The study aims to model and compare the behavior, determinants, and volatility characteristics of both exchange rates. Methodology: The study employs time series econometric techniques, including ARIMA, ARIMA-GARCH, ARIMAX, and ARIMAX-GARCH models. The Cairo Overnight Index Average (CONIA) and EGX 30 market returns are incorporated as exogenous variables. Volatility is modeled using several GARCH specifications (SGARCH, EGARCH, TGARCH, and GJR-GARCH) under alternative error distributions. Findings: The results show that the official exchange rate is significantly influenced by EGX 30 returns, while its autoregressive and moving average components are insignificant. In contrast, the unofficial exchange rate exhibits strong autoregressive and moving average dynamics but is unaffected by the selected exogenous variables. Moreover, the unofficial exchange rate displays pronounced volatility clustering, best captured by an SGARCH model with a student’s t-distribution. Unique Contribution to Theory, Practice and Policy: This study fills a major gap in the exchange rate literature by explicitly modeling Egypt’s unofficial exchange rate and its volatility. The findings provide investors and policymakers with a robust framework for understanding exchange rate risk in dual-market environments. Policymakers are encouraged to account for unofficial market dynamics when designing exchange rate and monetary policies, while investors can use the proposed modeling approach to improve risk assessment and forecasting accuracy.