An Empirical Analysis of the Relationship between Exchange Rate and Stock Prices in Nigeria

ABSTRACT 

This study examines the causal relationship between exchange rate and stock prices in Nigeria using quarterly data for the period of 1990-Q1 to 2009-Q4. The ADF and PP tests suggest that the series are random work processes in their level form. Pair-wise Granger Causality was tested within multivariate co-integration and vector error correction model (VECM) framework. Three different stock exchange indicators were used as proxy for stock prices to test the direction of causality between the variables. Thus we have three VAR models. The empirical findings suggest evidence of long run equilibrium relationship between exchange rate and stock prices. It further shows that there is strong unidirectional causality running from stock prices to exchange rate irrespective of the stock market indicator used. The result supports the Stock Oriented Model (SOM). The estimated cointegrated vector showed that exchange rate exerts negative impact on Nigerian stock prices. Evidence from vector error correction term revealed that the speed of adjustment is high when SMC was used as proxy for stock prices, followed by ASI and VST. The Impulse Response Function (IRF) shows that shocks in foreign exchange market and macroeconomic environment tend to worsen the Nigerian stock market. The ASI accounted for 84.7% while EXR explained for 12.3% of forecast error variance in the stock market. This suggests that information in the stock market seem to be the driving force behind stock market variance.

TABLE OF CONTENTS

Title Page ---------------------------------------------------------------------------------------- i

Certification ------------------------------------------------------------------------------------- ii

Approval page ----------------------------------------------------------------------------------- iii

Dedication --------------------------------------------------------------------------------------- iv

Acknowledgement ------------------------------------------------------------------------------ v

Table of contents ------------------------------------------------------------------------------- vi

Abstract------------------------------------------------------------------------------------------- viii

CHAPTER ONE:

1.0 Introduction ----------------------------------------------------------------------------- 1

1.1 Background of the Study -------------------------------------------------------------- 1

1.2 Statement of the Problem -------------------------------------------------------------- 3

1.3 Objective of the Study ------------------------------------------------------------------ 7

1.4 Research Hypothesis -------------------------------------------------------------------- 7

1.5 Significance of the Study -------------------------------------------------------------- 7

1.6 Scope of the Study ---------------------------------------------------------------------- 8

CHAPTER TWO:

2.0 Literature Review ---------------------------------------------------------------------- 9

2.1 Overview of the Nigerian Stock Exchange ----------------------------------------- 9

2.1.1 Nigeria Stock Market Measures ------------------------------------------------------ 10

2.2 Overview of Exchange Rate Regime ------------------------------------------------ 11

2.3 Evaluation of Foreign Exchange Rate in Nigeria --------------------------------- 12

2.4 Current Structure of Foreign Exchange Market ------------------------------------ 13

2.5 Theoretical Framework ----------------------------------------------------------------- 14

2.6 Empirical Literatures ------------------------------------------------------------------- 16

2.7 Limitation of Previous Nigeria Studies --------------------------------------------- 23

CHAPTER THREE:

3.0 Methodology ---------------------------------------------------------------------------- 24

3.1 Analytical Framework of the Model ------------------------------------------------- 24

3.2 The Model ------------------------------------------------------------------------------- 24

3.3 Definition of model Variable ---------------------------------------------------------- 25

3.4 Justification for the Model ------------------------------------------------------------ 26

3.5 Estimation Procedure ------------------------------------------------------------------- 27

3.6 Data and their Features ----------------------------------------------------------------- 29

3.7 Econometric Softwares ----------------------------------------------------------------- 30

CHAPTER FOUR:

4.0 Empirical Results and Discussion ---------------------------------------------------- 31

4.1 Unit Roots Test Results ---------------------------------------------------------------- 31

4.2 Co-integration Test Result ------------------------------------------------------------ 32

4.3 Vector Error Correction Model (VECM) Result ----------------------------------- 33

4.4 Interpretation of Pair wise Granger Causality Test Result ----------------------- 37

4.5 Impulse Response Function ----------------------------------------------------------- 38

4.6 Forecast Error Variance Decomposition ------------------------------------------- 38

4.7 Description Statistics ------------------------------------------------------------------ 38

4.8 Test of Multicollinearity --------------------------------------------------------------- 40

CHAPTER FIVE:

5.0 Summary of Finding and Recommendation ---------------------------------------- 42

5.1 Summary of Findings ------------------------------------------------------------------- 42

5.2 Policy Recommendations ------------------------------------------------------------- 43

References --------------------------------------------------------------------------------------- 45

Appendix ---------------------------------------------------------------------------------------- 51