Foreign Portfolio Investment And Stock Market Development in Nigeria

The exposure and vulnerability of financial markets in developing countries have been at center stage of empirical debates in recent time. The crux of the debate is not whether the financial system is isolated or not but the extent of such exposure. As an attempt to investigate the Nigerian exposure to external shock, this paper investigates the impact of foreign portfolio investment on the stock market between the study period of 1980 and 2014. Data for the study were sourced from the statistical bulletins published by the Central Bank of Nigeria. A model that captures the fundamental drivers of stock market development was built while the time series properties of the variables were examined using Augmented Dickey Fuller and Johansen co-integration tests. In view of the results of the pre-estimation tests, the Error Correction Modeling approach was used to estimate and examine the relationship between foreign portfolio investment, stock market development and other variables such as economic growth, exchange rate and inflation rate. The results show that there was a significant positive long run relationship between foreign portfolio investment and stock market development. It was also found that the level of domestic economic activities, exchange rate and inflation rate were other key fundamentals dictating the momentum of investment flow and direction of stock market development in Nigeria. The lagged error correction term (ECMt-1) is −0.012 indicating that the speed and time to full adjustment from short run shock to long run stability is low. The paper concludes that portfolio investment is a major driver of stock market development and more importantly, the main channel through which external financial instability is transmitted into the Nigerian economy. The policy implication is that increase in the foreign portfolio investment increases the domestic stock market performance. This could however lead to a great instability and financial distress if the enabling domestic macroeconomic conditions and policy framework to insulate the stock market against the vagaries of external shocks are not properly coordinated.