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

Abstract

In the recent past and specifically 2015 and early 2016, the Kenya shilling was depreciating in value and at the same time the NSE 20 share index and all-share index were also declining. Different opinions have been given towards the fall in the indexes. The main argument is that a weak currency increases the finance cost of the listed company leading to increased debt and relatively less profit. Athi River Mining, one of the listed companies has been experiencing this problem due to the amount it owes to a Lagos-based Africa Finance Corporation (AFC). This has led its reduction in profits and share price. The main observation against this relationship is that despite the Kenya shilling weakening, stock prices have increased in some sectors of the economy e.g. the agricultural sector, whose current stock prices has increased due to cheap exports. This study thereby confirms if this reason given by analysts is true and whether investors, borrowers, stock brokers and the regulatory authority can use this study to predict the stock market performance. This research sought to determine the relationship between exchange rate volatility and stock market performance in the Nairobi Securities Exchange. Three major theories relating to the two variables are introduced to explain the relationship. Results of different scholars who have conducted their studies in stock markets across the globe will be presented in this research and an explanation of how they arrive at their conclusion. Descriptive research design was adopted for this study in which secondary data from the Central Bank of Kenya was gathered over the period January 2007- June 2017. The collected data was analyzed by use of Statistical Package for Social Sciences (SPSS) version 21. Regression and correlation analysis were done to determine the effects of exchange rate volatility on the performance of the stock market. Other macro-economic factors i.e. Inflation volatility and interest rate volatility were also included to determine the impact it had on the performance in the stock market. It was established that exchange rate volatility is among the determinants of stock market performance though not very key. Lastly, results showed evidence of time varying in stock market returns and from the asymmetric model, results indicate that bad news has larger impact on stock volatility than good news in the NSE using change in inflation, whereas the opposite, was established for inflation itself. Secondly, results show that inflation is one of the underlying determinants of stock market volatility. But, previous inflation change was found to have less impact compared to inflation rate itself on stock returns. These results, therefore, would be useful to investors and other market operators in making good portfolio decisions and for stemming the adverse effect of inflation on stock market.