The Relationship between the Rate of Foreign Exchange and the Stock Prices at the Nairobi Stock Exchange

Abstract

This research aimed at investigating whether exchange rates and stock prices are related. The focus was on the effect of the rate of Kenya shilling exchange for the Dollar, the Sterling Pound and the Euro on the Nairobi Stock Exchange 20-share index. The simple linear regression model was fitted where the currencies were treated as independent variables while the 20-share index was treated as the dependent variable, for the daily trading data for three months between July and September 2005.

The ordinary least square method of analysis was carried out and an f-test statistics done. The result showed that there is negative linear relationship between the Kenya shilling exchange rate for both the Dollar and the Euro on the Nairobi Stock Exchange (NSE) 20-share index. This implies that as shilling depreciates against the two currencies, the NSE 20-share index increases and vice versa. However, there was no linear relationship between the Kenya shilling rate of exchange for the Sterling pound and the 20- share index implying that whether the rate of shilling exchange for Sterling pound appreciates or depreciates it does not affect the share pricing at the NSE.

This study has implications for local investors and exporters because it provides a strategy on whether it is appropriate to invest in shares or export commodities at a particular Dollar and Euro rates. Also market regulators may use causality modelling techniques to forecast share prices in short-run.