The Effect of Foreign Exchange Fluctuations on Equity Market Performance of the Nairobi Securities Exchange

Abstract

The stock market serves to symbolize the performance and well-being of the economy and is tracked as an indicator of overall economic activity. The effects of various macroeconomic indicators on the stock exchange have been evaluated in numerous studies over the years. This study sought to establish the nature of the interaction between foreign exchange fluctuations and their impact on equity market performance at the Nairobi Securities Exchange. Previous studies have offered up mixed results as to the direction of this relationship. A correlational research design was drawn up with the NSE 20 Share Index as the dependent variable representing market performance; the Kenya Shilling-US Dollar exchange rate served as the independent variable representing exchange rate fluctuations. The paper employed monthly time series data covering a 10-year span, dating from July 2006 until June 2016. The exchange rate and market performance were found to be asymmetric and not follow a normal distribution, instead they were found to follow leptokurtic distributions; such a distribution has fat tails and the data points are more clustered around the mean. From a correlation perspective, it was observed that the two variables were negatively associated and moved in opposing directions to one another. The study applied an Exponential Generalized Autoregressive Conditional Heteroskedasticity (EGARCH) model to assess the impact of foreign exchange fluctuations on stock market performance. The exchange rate was found to have a negative significant effect on stock market returns, albeit of low magnitude. This fit in with the overarching theory that adverse currency movements would impact the stock market performance. The study findings can be helpful to investors in understanding how exchange rate dynamics impact market performance and guide them in making decisions on investment strategy. It is recommended measures aimed at ensuring stability in the foreign exchange market should be employed so as to build up investor confidence and encourage improved market performance at the Nairobi Securities Exchange.