Investigating The Relationship Between Stock Prices And Exchange Rates In Zambia

Abstract

This study sets out to investigate the relationship between stock prices and exchange rates in Zambia. The relationship between the two variables is well explained by the portfolio balance and the traditional approaches to exchange rates determination. The portfolio balance explains that stock prices lead exchange rates by affecting investors’ wealth and interest rates in an economy; on the other hand the traditional approach explains that exchange rates leads Stock prices. There have been many empirical studies on the relationship between the variables but no consensus has been reached at as to which variable causes the other. Many of these studies have been motivated by the movements of the variables in times of financial crises in different parts of the world, such as global financial crisis of 2007/8. This study is motivated by the fact that there has been no study on the subject using Zambian data set; hence the study adds to the body of knowledge in this regard. The study employs Johansen cointegration test and the results show that there is no long run relationship between stock prices and exchange rates in Zambia; that is, the variables do not move together in the long run. Furthermore, Granger causality test show no causality from stock prices to exchange rates and from exchange rates to stock prices. The EGARCH estimation results show that volatility in stock market persists and that positive shocks in the stock market generate more volatility than negative shocks. The government should use political atmosphere to create a favourable investment climate and expand its traditional exports. Data for stock exchange was collected from the Lusaka Stock exchange and nominal exchange rates from the Bank of Zambia.