On the connectedness of stock returns and exchange rates in emerging and frontier markets in Africa

Abstract

AbstractThe effect of currency volatility on investments in Africa continues to dominate the headlines, especially in the recent period of global crisis and heightened geopolitical tensions. This paper tackles the dynamic relationship between stock returns and exchange rates in nine emerging and frontier African markets. The study departs from the usual VAR and GARCH models and employs a tool that accounts for time–frequency co‐movements and lead/lag relationships between exchange rates and stock returns in Africa. The bivariate wavelet technique applied to daily data from 1 April 2013 to 31 March 2022 established a profound negative co‐movement between stock returns and exchange rates, especially in the medium to long‐term frequencies. With exchange rates dominantly playing a leading role, it presents a case for policy consideration toward currency stability. We employed the partial wavelet approach to determine how stock returns and exchange rates related during the peak period of the COVID‐19 pandemic and found negative co‐movements within the short‐term frequency, revealing that investors preferred the short‐term horizon in times of crisis. However, when the covariate (COVID‐19) was controlled or suppressed, we discovered the health pandemic failed to drive both stock returns and exchange rates.