Essays on exchange rate movements and stock returns in emerging and frontier African economies

Abstract

Global financial markets have recently undergone significant turmoil due to numerous factors, such as economic uncertainties, pandemics, geopolitical tensions, and extreme contagion. Unfortunately, African economies are not immune to these global developments and are often impacted by risk-off sentiment. As a result, these shocks have significant consequences for African exchange rates and capital markets. Due to the region's trade and investment dynamics, African economic policymakers rely heavily on exchange rate management as a policy tool. Additionally, capital flows in the form of equities are important for Africa’s growth agenda. The research explored four distinct, yet interconnected essays related to currency and equity movements in Africa, aiming to offer valuable insights into investment and policy considerations while enriching the existing literature. The first essay explored the connection between currency movements and equities in Africa. This approach departs from the usual VAR and GARCH models and employs a tool that accounts for time-frequency co-movements. This is critical for investment and policy decisions as it better explains which part of the sample period produces shocks. Given the recent market uncertainties, this study suggests that investors can determine the right investment horizon. The bivariate wavelet technique established a profound negative correlation at the upper end of the horizon, making room for diversification opportunities. With exchange rates playing a dominant leading role, it presents a case for policy considerations towards currency stability. The partial wavelet results revealed that investors should scale down to the short end of the investment horizon during crisis periods like COVID-19. In the second essay, the asymmetric linkages were modelled between stock returns of developed economies and African markets using quantile regressions along 0.05 quantile iii | P a g e intervals. The crux of this study is to determine the options available to holders of African stocks considering market integration. Having employed the U.S. and U.K. as proxy for advanced markets, we found diversification and hedging benefits from the two advanced markets for some African equities at different time scales. The quantile-on-quantile regression results revealed that both U.S. and U.K. stocks could offer safe-haven benefits for some African equities in extreme market conditions. The findings strongly project that investors making decisions to mitigate risks must appreciate the heterogeneity in the nexus between the advanced markets and African economies to arrive at optimal risk-adjusted returns The third essay applied transfer entropy techniques for the examination of information flows between advanced and African markets. Information content analysis is vital in the current investment and portfolio management dispensation. Findings from the information exchanges indicated that some African markets have led the market integration process ahead of their peers. This study compared significant periods of global interest, such as the Fed normalisation period and BREXIT. The results present important implications for risk management strategies and policy measures to anchor markets to withstand shocks. Due to the potential scales of investments from market integration with advanced markets, African policymakers are encouraged to champion this agenda. However, this requires the need to build economies to withstand shocks. Similarly, in the last essay, the information content was modelled between currencies of advanced markets and African economies. Exchange rate spillovers have significant implications for emerging and frontier economies due to the linkages between currency performance and other key variables. The essay examined information exchanges with the iv | P a g e world’s most liquid currencies over different crisis periods. The results possess essential implications for risk management strategies and policy frameworks, especially in this current period of heightened global uncertainties. Due to the spillovers in the currency market, African policymakers should be wary about the susceptibility of their currencies to global shocks.