The Casual Relationship Between Exchange Rates and Stock Prices in Kenya
Abstract
At the least complicated level of economic theory lies the belief that certain pairs of
economic variables should not diverge from each other by too great an extent, at least in
the long-run. Thus, such variables may drift apart in the short-run or according to seasonal
factors, but then economic forces, such as market mechanism or government intervention,
will begin to bring them together again. Such variables include exchange rates and stock
pnces.
This study examines the causal relationship between foreign exchange rates and stock
prices in Kenya from November 1993 to May 1999. The data set consists of monthly
observations of the NSE stock price index and the nominal dollar exchange rates. The
objective is to establish the causal linkages between leading prices in the foreign exchange
market and the Nairobi Stock Exchange (NSE). These linkages have implications for policy
makers, regulators, investors , financial intermediaries and the management of publicly
owned companies in Kenya.
This study employs cointegration and error-correction methodology. This statistical
technique is not only simple to apply and relevant to analysing time series data, but also for
ensuring stationarity and providing additional channels through which causality could
emerge if two variables are cointegrated ..
As a matter of procedure, we first tested for stationarity and the order of integration of the
time series data. The empirical results show that foreign exchange rates and stock prices
are nonstationary both in first differences and level forms, and the two variables are
integrated of order one, in Kenya. Secondly, we tested for cointegration between exchange
rates C'-1dstock prices in Kenya. The results show that the two variables are cointegrated.
Thirdly, we used error-correction models instead of the classical Granger-causality tests
since the two variables are cointegrated.
to
The empirical results obtained from the error correction model, over the period November
1993 to May 1999 indicate that exchange rates.G,ranger -causes stock prices in Kenya.
There exists unidirectional causality from exchange rates to stock prices. Therefore,
movements in exchange rates exert significant influence on stock price determination in
Kenya.
Citation
MBASponsorhip
University of NairobiPublisher
University of Nairobi School of Business, College of Humanities and Social Sciences