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

Odongo Kodongo and Kalu Ojah ()

MPRA Paper from University Library of Munich, Germany

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.

Keywords: Currency risk; inflation risk; stochastic discount factor; Africa’s equity markets (search for similar items in EconPapers)
JEL-codes: F21 F31 G12 G15 (search for similar items in EconPapers)
Date: 2014-05-20
New Economics Papers: this item is included in nep-afr
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