Analysis of Stock Prices and Exchange Rate Interactions in Nigeria

Description

– Analysis of Stock Prices and Exchange Rate Interactions in Nigeria –

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Abstract

The need to capture stock market and foreign exchange market nexus in Nigeria is underscored by the rapidly expanding financial markets integration due to trade and financial liberalization policies which seem to have enhanced the inflow of capital as well as accelerated investment/business interactions.

Theoretically, the relationship between stock prices and exchange rate can be either positive or negative and can also run either way. This study therefore captures returns/mean and volatility spillovers between the stock and foreign exchange markets in Nigeria.

The study empirically analyzes stock prices and exchange rate interactions with VAR and multivariate generalized autoregressive conditional heteroscedasticity (GARCH) models using monthly data from January 2000 to October 2014.

The results of the E-G and Johansen cointegration test show that there is stable long-term equilibrium relationship between stock prices and exchange rate.

The empirical evidence of the VAR-GARCH model shows a significant mean spillover running from stock market to exchange market but not a mean spillover from exchange market to stock market.

Introduction

1.1 Background of the Study

The relationship between stock prices and exchange rate has attracted much attention amongst financial expert, researchers and policy makers in Nigeria since the inception of the Structural Adjustment Programme (SAP) in 1986.

The period witnessed significant changes in the Nigerian financial system, such as the emergence of new equity markets in terms of liberalization policy.

This era saw the abolishment of trade barriers on capital flows and adoption of flexible exchange rate, which subsequently result to verities of investment opportunities. Hence, the broadened investment opportunities in turn promote frequent inflow and outflow of investment into the market.

As a result, this has led to the increase in demand and supply for local currency and thus, the volatility in exchange rates that sometime affect the investment decisions and portfolio diversification of many investors.

However, the understanding of the influence of exchange rates on stock prices and their interactions in Nigeria cannot be over-emphasis. This is because of the significant role they play in stabilizing the macroeconomic environment, which in turn spur economic growth and development.

Though, there has been thoughtful disagreement on the relationship between stock prices and exchange rate. It has been argued that the interplay of demand and supply of domestic currency partly determined stock price movement (Bahmani-Oskooee & Sohrabian, 1992).

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