DOES OVERVALUATION OR UNDERVALUATION OF NAIRA EXCHANGE RATE AFFECT STOCK PRICES DIFFERENTLY? EVIDENCE FROM NONLINEAR ARDL

Abstract

The relationship between stock prices and exchange rates misalignment has not received too much attention. The result from most of the previous studies have shown that the relationship between the variables is short run with few indicating that they have long run relationship. Also, the few existing studies on the nexus between exchange rate misalignment and stock prices assumed a symmetric relationship between the two variables. The mixed result from previous study is due to the assumption of linearity. In this paper, we use quarterly data for Nigeria from 1991 to 2018 to check the possibility of asymmetry in the relationship by decomposing the misalignment series into overvaluation and undervaluation using non-linear ARDL method. The result show evidence of short run and long run asymmetry, this implies that the effects of undervaluation will last over much longer period than the effects of overvaluation. These findings have implication for market participants as well as policy makers. In managing the exchange rate, policy makers must be aware of the asymmetric effect of their action on the stock market as they try to devalue domestic currency for the purpose of improving trade balance.