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The conditional pricing of currency and inflation risks in Africa's equity markets

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  • Kodongo, Odongo
  • Ojah, Kalu

Abstract

Globalization of financial markets has increased correlation among developed economy markets and made developing economy markets attractive for diversification purposes. Among the developing economy markets are African equity markets, which appear to be the most promising and yet the least studied. Taking the perspective of foreign investors, we estimate the stochastic discount factor (SDF) model for a cross-section of major equity markets in Africa over the period 1997-2009, using the Generalized Method of Moments (GMM). Our findings suggest that real exchange rate risk constitutes a significant time-invariant component of returns in Africa’s equity markets. We also find that inflation and nominal exchange rates are separately priced, with time-varying risk premia. Given these findings, international equity investors interested in Africa should hedge their positions against currency risk. Accordingly, African governments should prioritize the development of hedging instruments to increase their equity markets’ investability.

Suggested Citation

  • Kodongo, Odongo & Ojah, Kalu, 2014. "The conditional pricing of currency and inflation risks in Africa's equity markets," MPRA Paper 56100, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:56100
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    1. repec:eee:riibaf:v:42:y:2017:i:c:p:1228-1243 is not listed on IDEAS
    2. Azad, A.S.M. Sohel & Batten, Jonathan A. & Fang, Victor, 2015. "What determines the yen swap spread?," International Review of Financial Analysis, Elsevier, vol. 40(C), pages 1-13.

    More about this item

    Keywords

    Currency risk; inflation risk; stochastic discount factor; Africa’s equity markets;

    JEL classification:

    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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