The Effect of Political Risk on Exchange Rates in Kenya

Abstract

Recently, exchange rate and political risk are highly addressed by international economics literature as the factors playing an important role in the world economy. Political risk is often referred as an indicator of countries’ institutions quality. On the other hand exchange rate might be considered as an indicator of the whole economy performance. Thus, this paper empirically examines the effect of political risk on exchange rates in Kenya with a daily time series data of 3 currencies for the period May 2010 to April 2013. Main results and conclusions are based on the Event Study methodology. The market model utilized interbank rate to calculate Abnormal Returns and Cumulative Abnormal Returns. Test of significance was conducted using t-test with 10% level of significance using a two tailed test. From the collected data it was observed that politically risky events had a statistically significant effect on exchange rates for USD. The regional currency USH however did not show such a significant relationship. The other currency under study which was the EURO did show very minimal reaction to the political events. This study recommends that policy makers should therefore come up with methods of mitigating political risk such as establishment of a private independent Central Bank.