The Effect of Exchange Rate Volatility on Market Returns at the Nairobi Securities Exchange

Abstract

Foreign exchange rate volatility has implications on the economic activities of any country since it affects the importation and exportation of goods and services by firms. In addition, foreign investors shift funds to markets whose prices are fair or undervalued and have a potential for high returns. This may ultimately be reflected in the market returns. The study sought to examine the effects of exchange rate volatility on the market returns at the Nairobi Securities Exchange over the period January 2007 to December 2016. The study used secondary data from the websites of the Nairobi Securities Exchange and the Central Bank of Kenya. The study employed multiple regression model and correlation analysis. On the one hand, the NSE 20 share index was the dependent variables while on the other hand the macroeconomic fundamentals namely foreign exchange volatility, monthly average interest rate and monthly inflation rate were the dependent variables. The economic theories postulate a relationship between exchange rate volatility and market returns but do not conclusively define the direction of the relationship. The study established that foreign exchange volatility, average interest rate and average rate of inflation explain 14.22% change in market returns. The study further established that foreign exchange volatility has a positive but insignificant relationship with the market returns. The average monthly rate of inflation has a negative and significant relationship of 36.26% change in market returns implying investors shift resources from the market when inflation increases. The study further established that the monthly average rate of interest has a negative but significant relationship of 23.89% with market returns meaning investors shift from securities to interest bearing investments such as bonds. The findings also established that the Kshs had depreciated gradually against the USD over the period of study and this may have had adverse implications on businesses and the general economy