The Relationship Between Exchange Rate Movement and Stock Market Returns Volatility at the Nairobi Securities Exchange

Abstract

Domestic currency depreciation makes local firms more competitive, leading to an increase in their exports. This in turn raises their stock prices. A weak or no association between stock prices and exchange rates can also be postulated. Transaction costs and sunk costs of market entry imply that only large exchange rate movements affect market structure and, thereby, firms’ market value. Therefore, like prices of other assets the exchange rates are determined by expected future exchange rates. Any news/factors that affect future values of exchange rate will affect today’s exchange rate. This study set to establish the relationship between exchange rate movement and stock market returns volatility at the Nairobi Securities Exchange. The study adopted a quantitative design. The target population for this study included 56 companies quoted at the NSE as of December 2011. Since the population was small and the study is using secondary data, the study conducted a census. The study used secondary data collected from the Nairobi Securities Exchange and the Central bank of Kenya for the period 2007-2011. The study regressed stock market returns volatility against exchange rate movement. From the regression output, the study established that exchange rate movements greatly affected the stock market return volatility owing to its information content to the investors. With high fluctuations in the exchange rates, the exchange rates movement became bigger accompanied by a huge stock market return volatility. Study concludes that there is a strong relationship between exchange rate movement and stock market returns volatility. This is especially carried through the information content of exchange rate movement on the security’s business. The study concludes that exchange rate movement also affects the stock market performance greatly through its spiral effects. Through over macroeconomic variables, exchange rate movement indicates the state of the economy hence the likely future state of the economy. These variables would include things like interest rate and the money supply in the economy which has great impact on the activity level of the security’s performance. The policy makers need to factor the effects of exchange rate movement on the performance of the stock exchange.