The Effect Of Exchange Rate Changes On Stock Market Returns At The Nairobi Securities Exchange

Abstract

Exchange rate is an important macroeconomic factor driving economies around the world. Equally important, is the performance of the stock market. Literature on the effect of exchange rate on stock market performance indicates mixed findings. This is an indication that debate on the relationship between exchange rate and stock market share indices around the world is still far from over. Arising from this, the study had sought to investigate the effect of real exchange rate on the Nairobi Securities Exchange. The study focused on the Nairobi Securities Exchange 20 share index and the Kenya shillings/United States Dollar real exchange rate. The study applied simple regression (ordinary least squares) on half-yearly data for 16 years, that is, from 2001-2016. Data was obtained from Nairobi Securities Exchange data base, Kenya National Bureau of Statistics, and the United Nations Conference on Trade and Development. Since ordinary least square regression estimates are affected by multicollinearity and heteroscedasticity problems, multicollinearity and heteroscedasticity tests were conducted on the variables. These tests confirmed the absence of both multicollinearity and heteroscedasticity meaning that the estimated coefficients are valid, and the study can draw reliable inferences. Findings indicate that real exchange rate is significant and positively correlates with the Nairobi Securities Exchange index. In addition, the rate of inflation was also found to be significant but with a negative sign (relationship). Based on these findings, the study recommended for the government to put in place better policies to manage levels of inflation.