The interplay between exchange rate regimes and asset prices : a comprehensive investigation

The study aims to explore the systematic factors affecting asset returns in Africa, particularly the dynamic and asymmetric impact of macroeconomic variables on stock returns by incorporating exchange rate regimes into the valuation process. This aim is motivated by the disparity between the surge in global portfolio equity flows, reaching $1.3 trillion1 in 2021, and the limited investment inflows into Africa, despite the region's robust economic growth averaging 4% over the last decade. While Modern Portfolio Theory suggests that investors may be attracted to regions with higher expected returns, barriers such as information scarcity and historical volatility, including currency crises, have hindered investment inflows into Africa. To fill this information-gap a robust theoretical and empirical framework is needed that will act as a frame of reference for those who want to invest in the region. The study seeks to test the hypothesis that various prespecified macroeconomic factors exert differing asymmetric and dynamic influences on the returns of asset prices, in different exchange rate regimes. To investigate the above, the research comprised three distinct but progressively dependent sub studies, using a combination of Probit, Vector Autoregressive Regression, Threshold Generalized Autoregressive Conditional Heteroskedasticity and Nonlinear Autoregressive Distributed Lag regression models. The study uses quantitative datasets from six African Countries for the period ranging from 1980-2021. The study reveals periods of misalignment between the shocks identified by composite indices and stated exchange rate policies, particularly evident in Algeria and Ghana. The study underscores the disparity between de jure and de facto exchange rate regimes, aligning more closely with IMF classifications post-2009. Furthermore, it elucidates how macroeconomic factors react differently across exchange rate regimes and to various shocks, highlighting contrasting responses in output, inflation, exchange rates, and interest rates. Statistical analyses unveil significant changes in relationships between variables across exchange rate regimes and shocks, indicating nuanced dynamics within each country's economic landscape. Notably, the study identifies mean-reverting behavior in stock indices across all countries and reveals the exchange rate regime's role as an effect modifier, influencing the marginal effect differently in each country. Moreover, it demonstrates asymmetrical responses to variables, contributing to a deeper understanding of volatility and stock market behavior. This research emphasizes the need for tailored policy interventions and investment strategies based on each country's economic context and calls for further exploration of additional factors influencing stock returns. Unique contributions include the development of novel tools to measure shock vulnerability and identify exchange rate regimes, along with the incorporation of asymmetric impacts into stock pricing and volatility measurements, particularly in sub-Saharan Africa. The study suggests expanding these analyses to other regions and asset classes to assess the universality of the concepts developed herein.