The Causal Relationship between Exchange Rates and Stock Prices in Kenya

Abstract

This study examined the causal relationship between foreign exchange rates and stock prices in Kenya from November 1993 to May 1999. The data set consisted of monthly observations of the NSE stock price index and the nominal Kenya shillings per US dollar exchange rates. The objective was to establish the causal linkages between leading prices in the foreign exchange market and the Nairobi Securities Exchange (NSE). The empirical results show that foreign exchange rates and stock prices are nonstationary both in first differences and level forms, and the two variables are integrated of order one, in Kenya. Secondly, we tested for cointegration between exchange rates and stock prices. The results show that the two variables are cointegrated. Thirdly, we used error-correction models instead of the classical Granger-causality tests since the two variables are cointegrated. The empirical results indicate that exchange rates Granger-causes stock prices in Kenya.

Keywords: Exchange rate, Stock prices, Causality, Unit root, Error-correction models, Kenya