The Extent of the impact of exchange rate fluctuations on stock returns at the Nairobi Securities Exchange (NSE)

Abstract

The purpose of this study is to establish whether changes in the exchange rate are sufficient in explaining stock returns at the Nairobi Securities Exchange (NSE). Previous scholars have determined a causal relationship between the NSE and the exchange rate (domestic currency to US dollar). Other studied macroeconomic variables have been determined not to be significant in explaining stock returns. This study introduces two new variables: the interbank rate and the trade balance. Monthly time series data was collected from January 2018 to May 2024 for use in the analysis. An Autoregressive Distributed Lag (ARDL) model was employed to examine the short- and long-run dynamics of the effects of the exchange rate, interbank rate and the trade balance on stock return behavior at the NSE. In the short run, changes in the exchange rate and the previous monthly change in the trade balance are revealed to have significant negative relationships with NSE stock returns. The study established a negative long-term relationship between changes in the exchange rate and stock returns. Moreover, the study found a positive long-term relationship between changes in the trade balance and stock returns. Policymakers may use the findings of the study to pursue policies that stabilize the exchange rate to support investor confidence and stock market performance. Investors may use the results to monitor developments in the stock market by observing the foreign exchange market and the goods market.