The dynamic relationship between stock prices and exchange rates - A case of Kenya

Abstract

This study investigates the price t1uctuations and volatility spillover effects as well as the relationship between the stock market and the currency market in Kenya. The study developed long run and short run models for the exchange rate and stock price index with data ranging from between January 2004 to December 2014. The Data was obtained from the Nairobi Stock Exchange for the stock prices and the US DIKES exchange rate from the Central Bank of Kenya website. The study uses the Vector error correction model to determine the short run relationship 'and the significant price transmission effects' between the markets whereas the EGARCH' model is used to determine the volatility effects as well as the conditional variances of each of the variables. The study finds that there is no causal relationship between the stock market and exchange rate market; however it finds that there is significant volatility and price spillover effects from the foreign exchange market to the stock market and vice versa. This dynamic relationship opens up avenues for further research into other factors that may affect these two variables such as interest rates, which may be used to better explain the transmission of price spillovers between the currency and stock markets.