Analysis of Stock Prices and Exchange Rate Interactions in Nigeria

ABSTARCT The need to capture stock market and foreign exchange market nexus in Nigeria is underscored by the rapidly expanding financial markets integration due to trade and financial liberalization policies which seem to have enhanced the inflow of capital as well as accelerated investment/business interactions. Theoretically, the relationship between stock prices and exchange rate can be either positive or negative and can also run either way. This study therefore captures returns/mean and volatility spillovers between the stock and foreign exchange markets in Nigeria. The study empirically analyzes stock prices and exchange rate interactions with VAR and multivariate generalized autoregressive conditional heteroscedasticity (GARCH) models using monthly data from January 2000 to October 2014. The results of the E-G and Johansen cointegration test show that there is stable long-term equilibrium relationship between stock prices and exchange rate. The empirical evidence of the VAR-GARCH model shows a significant mean spillover running from stock market to exchange market but not a mean spillover from exchange market to stock market. Furthermore, the variance equation results show that there exist bi-directional volatility transmission effect between the two markets, indicating the past innovations in stock market have the great effect on future volatility in foreign exchange market, and vice versa. The results have important implications for international portfolio managers in the portfolio diversification decisions and risk hedging strategies