Assessing the pricing of currency risk in the Kenyan stock market

Abstract

The Arbitrage Pricing Theory of Ross ( 1976) provides the theoretical framework for the three factor unconditional asset pricing model used in this study. Using the Generalized Method of Moments procedure the traditional two-step procedure of Fama and Macbeth was implemented. The study used four mean variance efficient p01tfolios created form the returns of 39 companies that were continuously listed on the NSE from 1999-2008 to investigate whether currency risk is priced in the Kenyan equity market. The three factor model fails to reject the hypothesis of a non-priced foreign exchange risk factor in the mid and large cap portfolios: p01tfolio 2, 3 and 4 (companies whose market capitalization ranges from, 1.275 billion to 4.68 billion, 5.245 billion to 26.7 billion and 31.9 billion to 245 billion respectively). On the other hand the model finds foreign exchange risk to be weakly priced in the small cap portfolio (portfolio I, companies whose market capitalization ranges from 7.29 million to 1.13 billion) and is able to reject the hypothesis that currency risk commands a zero premium in the Kenyan equity markets.