NATURE OF CAUSALITY BETWEEN EXCHANGE RATE AND STOCK PRICES IN KENYA
Abstract
Purpose of the study: The objective of the study was to examine the nature of causality between exchange rate and stock prices in Kenya.
Statement of the problem: In Kenya, there has been volatility in exchange rates that have been deemed to have an adverse effect on the share prices. Over the last five years, in the aftermath of 2008 post-election violence, both economy and the shilling suffered a serious decline. The foreign exchange rate has been fluctuating hitting an all-time high of Kshs/USD107 in the year 2011 from KShs/USD 87 in the year 2010. Nairobi All Share Index (NASI) plunged 30.45 percent to 68.08 points in 2011 down from the 97.82.
Methodology: The target population consisted of monthly observations of the Nairobi All Share Index (NASI) and the nominal Kenya shillings per US dollar exchange rates from the year 2008 to 2015. Secondary data was collected from Central Bank and Nairobi Securities Exchange. The research employed a Vector Auto-Regression (VAR) model. Granger causality approach was employed to infer information about the directions of causality between foreign exchange rates and stock prices.
Findings: The study found out that exchange rate Granger causes stock prices in Kenya.
Recommendations: The study recommends that causation should be vital tool of designing exchange rate policies. The investment banks should consider the linkage between stock market and exchange rate in risk management process. Besides, investors can consider this linkage in hedging against open exposure caused by foreign exchange volatility. The central bank should effectively strive to maintain a stable exchange rate through use of monitory policy tools since exchange rate volatility poses a financial risk to the country.
Keywords: Causality, Exchange Rate, Stock Prices, Kenya
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