Introduction
1.1 Background of the Study:
The relationship between stock prices and exchange rate has attracted much attention amongst financial expert, researchers and policy makers in Nigeria since the inception of the Structural Adjustment Programme (SAP) in 1986. The period witnessed significant changes in the Nigerian financial system, such as the emergence of new equity markets in terms of liberalization policy. This era saw the abolishment of trade barriers on capital flows and adoption of flexible exchange rate, which subsequently result to verities of investment opportunities.
Hence, the broadened investment opportunities in turn promote frequent inflow and outflow of investment into the market. As a result, this has led to the increase in demand and supply for local currency and thus, the volatility in exchange rates that sometime affect the investment decisions and portfolio diversification of many investors.
However, the understanding of the influence of exchange rates on stock prices and their interactions in Nigeria cannot be over-emphasis. This is because of the significant role they play in stabilizing the macroeconomic environment, which in turn spur economic growth and development.
Though, there has been thoughtful disagreement on the relationship between stock prices and exchange rate. It has been argued that the interplay of demand and supply of domestic currency partly determined stock price movement (Bahmani-Oskooee & Sohrabian, 1992). But this idea has been refuted by some scholars who believed that rise or fall in stock prices play a significant role in demand and supply of domestic currencies (Stavarek, 2005; Pan, Fok, & Lin, 2007). Thus, an appreciation of stock prices translates to the effectiveness of the market in terms of its performance. Therefore, an efficient market always attracts reasonable number of domestic and foreign investors. However, the inflows of foreign investors into the market due to its performance, causes increase in demand and supply of domestic currency.
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