Analysis of the relationship between exchange rate and stock prices: evidence from nigeria

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 walk 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 co-integrated 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 about 12.3% of forecast error variance in the stock market. This suggests that information in the stock market seems to be the driving force behind stock market variance.