Effect of the pricing of foreign exchange risk on stock returns at Nairobi Securities Exchange, Kenya.
Mmbayiza, Antony Muse
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The exits of purchasing power parity stipulates that different countries differ in prices for goods when a common digit is applied and therefore, random changes in exchange rate has often been implicated to be the key cause of fluctuations in prices leading to more risk in the assets pricing models. This implies that Exchange rate is a crucial variable that affect both the international competiveness of both multinationals and investor’s wealth as they participate in international stock markets. It then follows that investors and other players who participate by investing in stocks at the Nairobi Securities Exchange are not exceptional and therefore, this research seeks to empirically ascertain effects of the pricing of foreign exchange risk on stock returns on listed securities trading at Nairobi Securities Exchange, Kenya. The study covered a period of ten years starting from January 2003 to December 2012, with specific interest being to determine the degree at which inflation rate differential affected stock returns at Nairobi Securities Exchange, to examine the magnitude at which interest rate differential affected stock returns at Nairobi Securities Exchange and to analyze the extent to which current account deficit affected stock return at the Nairobi Securities Exchange. This research therefore employed monthly time series data while adopting the use of Unconditional three factor international arbitrage pricing model which formed the backbone on which the empirical model was based on. Moreover, all the sixty one (61) listed securities on Nairobi securities Exchange formed the population of this study. However by employing inclusion - exclusion criteria for survivorship biasness, only those securities that were in trade for the entire period formed a sample of thirty six (36) securities summing up to (59.02%) of the entire population. Empirically this study made use of linear regression equations that is orthogonalized based on actual values of the underlying factors. However, the researcher adopted the use of Generalized Method of Moments estimation technique to empirically analyze the data corresponding to the entire period under the study. This was supported with inbuilt E–Views computer software for data analysis. Since Generalized Method of Moments posits many advantages that make it free from Ordinary Least Square problems. It then follows that, by employing the services of Generalized Method of Moments, the data was presented in form of figures and tables with much emphasis being on descriptive analysis, testing of normality, stationarity and the prevalence of Ordinary Least Square problems. Using F and t– Statistics, Null hypothesis was tested at 5% confidence levels. This study is of critical use to academicians as it forms a foundation for future studies, to economists to draw implications of macroeconomic policy, investors to allocate appropriate risk level to their investment opportunities in Kenyan securities market as well as by multinational firms in diversifying their portfolio risk globally. The result revealed that foreign exchange risk was weakly priced and there existed a long run relationship between the interest rate differential and abnormal return, Current account deficit and Interest rate differential and between Interest rate differential and inflation rate differentials respectively. This meant that policy makers should consider regulating the interest rates and capping the inflation rate since they affect the purchasing power negatively. Moreover the CBK should consider empowering other currencies like Euros, yen, sterling pounds to diversify the impact of currency risk and integrate the Nairobi Securities Exchange to rest of the world securities markets.