Exploring the Role of Exchange Rate in Driving Market Capitalization in Nigeria

Abstract

The centrality of exchange rate in stock market performance cannot be over-emphasized. Thus, this study examined the dynamic effects of exchange rate on market capitalization in Nigeria. The specific objectives are to examine the effects of nominal exchange rate, real effective exchange rate, real interest rate and inflation rate on market capitalization using time series data which were obtained from the WDI and World Federation Exchanges Database between 1993 and 2020. Unit root test, cointegration test, ARDL estimation method, Granger causality tests were applied to analyze the data. The unit root test results showed that only market capitalization is stationary at levels whereas the other variables become stationary at first difference. The bounds cointegration test result revealed that market capitalization has long run relationship with the explanatory variables. The results revealed that real effective exchange rate impacted positively on the market capitalization. This implies that increase in real exchange rate (depreciation of the naira) creates opportunity for increase in the capital market size. The results further revealed that nominal exchange rate has an insignificant positive effect on market capitalization in the short run and long run. This could be linked to the inconsistency that characterizes the official exchange rate policy in Nigeria. It was also found that real interest rate has significant negative effect on market capitalization in the long run. At the same time, inflation rate negatively affected market capitalization. The Granger causality test results showed that a unidirectional causality runs from real interest rate and market capitalization. Given the findings, this study recommends that policymakers should ensure that the exchange rate management prioritizes a realistic and stable exchange rate to boost global competitiveness and improve market capitalization.