Linkages among energy price, exchange rates and stock markets: Evidence from emerging African economies

Abstract

ABSTRACTThis study examines the dynamic links among oil prices, foreign exchange rates and stock markets in emerging Africa using recent 10 years data and VAR-BEKK-GARCH forecasting framework. We find evidence of significant return and volatility interactions in oil return, exchange rates and stock markets. The non-existence of long-term cointegration equilibrium implies potential diversification benefit in the long run. Autoregressive characteristics for most African foreign currencies and stock markets indicate markets’ own predictability. We see that high oil return leads to an appreciation of Botswana pula, Nigerian dollar and Zambian kwacha, depreciation of Egyptian pound and boost the stock markets of Egypt, Kenya, Nigeria and Tunisia. From the conditional variance equation, we observe significant statistical evidence of local spillover effects from oil to financial markets. Strong bi-directional shock and volatility spillovers between oil and most African exchange rates are reported. Significant shock and volatility spillovers between oil and stock markets are found in some of the African countries. We conduct portfolio optimization analyses as part of the financial risk management and risk mitigation strategies. Policy wise, leaders should promote the development of financial derivative instruments since foreign exchange rates are used as a tool to absorb oil and other external shocks.