The Effect of Exchange Rate Risk on Stock Returns in Kenya’s Listed Financial Institutions

Abstract

Uncertainties in the flow of FPI result in unpredictable behaviour of stock returns in Kenya’s economy and also at the firm level. A huge surge of the inflows, for instance, can be very inflationary because this will force the Central Bank of Kenya to expand the country’s monetary base by releasing counterpart domestic currency which eventually feeds into the inflationary process. These inflows can also cause domestic currency appreciation if they are significant enough and thereby causing a mismatch in assets and liabilities of financial institutions. The objective of this study was to find out the effect of exchange rate risk on stock returns of listed financial institutions in Kenya. The target population of the study was 21 financial institutions listed on the Nairobi Securities Exchange. The study used purposive sampling technique and concentrated on 14 financial institutions. This study used a causal research design and adopted a panel data regression using the Ordinary Least Squares (OLS) method where the data included time series and cross-sectional. Hausman test was carried out and findings indicated that random effects model was preferable for this study. Results from panel estimation showed that exchange rate risk affect stock returns of listed financial institutions in Kenya.  The study recommended that the government of Kenya should enhance stability of macroeconomic factors such as foreign exchange rate through monetary policy as they affect the performance of securities exchange hence stock returns.

Keywords: Foreign portfolio equity purchases, Stock returns, financial institutions, Nairobi securities exchange, Kenya.