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

Abstract

There are number of reasons to believe that foreign exchange rate volatility should be a contributing factor in determining the stock market returns. Significant value of a nation’s capital is tied up in the stock market and investors’ wealth is at stake depending on how the market performs. There are cost implications on all economic agents as a result of foreign exchange market occurrences. Internationalization of capital markets has led to greater flows of money between market exchanges and in the cross-listing of firms. The appreciation of a currency reduces its ability to compete for exports; thereby hurting the domestic stock market. This study sought to determine the effect of foreign exchange rate volatility on stock market returns at the NSE. The independent variable was exchange rates as measured by monthly exchange rate between Ksh and USD. The control variables were inflation rates as measured by monthly CPI and interest rates as measured by monthly CBK lending rate. Stock market return was the dependent variable which the study sought to explain and it was measured by monthly returns computed from the 20 share index. Secondary data was collected for a period of 10 years (January 2007 to December 2017) on a monthly basis. The study employed a descriptive research design and a multiple linear regression model was used to analyze the association between the variables. Statistical package for social sciences version 21 was used for data analysis purposes. The results of the study produced R-square value of 0.113 which means that about 11.3 percent of the variation in stock market returns at the NSE can be explained by the three selected independent variables while 88.7 percent in the variation was associated with other factors not covered in this research. The study also found that the independent variables had a weak correlation with stock market returns (R=0.337). ANOVA results show that the F statistic was significant at 5% level with an F statistic of 4.949. Therefore, the model was fit to explain stock market returns at the NSE. The results further revealed that individually, exchange rates and inflation are statistically significant determinants of stock market returns at the NSE while interest rate is not a significant determiner of stock market returns. This study recommended that policy makers should pay attention to the prevailing foreign exchange rate volatility as they can negatively affect stock market returns recorded at the Nairobi Securities Exchange.