Interaction Effect between Exchange Rate Volatility and Stock Market Development on Economic Growth in Nigeria

Abstract

Despite unified exchange rates and financial reforms, Nigeria faces persistent exchange rate volatility and stock market instability, worsened by oil dependence and macroeconomic issues, hindering growth. The study examines the interaction among exchange rate volatility, stock market development and economic growth in Nigeria spanning from 1985 to 2023, sourced from Central Bank of Nigeria (CBN), Nigerian Stock Exchange (NSE), and World Bank databases, comprising time-series variables such as real GDP (RGDG) a proxy to economic growth (dependent variable), total market capitalization (TMC), all shares index (ASI) a proxy for stock market development, exchange rate volatility (EXRTV), investment rate (INVR), human capital (HC), external reserves (ERV), and money supply (M2GDP) are independent variables. The study hinges on endogenous growth theory, as theoretical framework. Similarly, GARCH was equally adopted as the study methodology to measure the volatility of exchange rate, all shares index and total market capitalization. While estimation techniques include ARDL bounds testing for cointegration, unit root tests (ADF and KPSS), and post-estimation diagnostics (CUSUM, normality, VIF). The study findings reveal SMD (TMC and ASI) positively impacts long-run EG, ERV negatively affects it, and their interaction (especially TMC) mitigates ERV's adverse effects; HC and ERV enhance growth, while INVR is negative and M2GDP insignificant. The study concludes that SMD fosters RGDP by buffering ERV-induced instability in Nigeria's oil-reliant economy. While the recommendations of the study include reforming stock markets for liquidity, stabilizing exchange rates via diversified reserves, and investing in human capital through education to promote sustainable development.