The Dynamics of Foreign Portfolio Investment, Equities Market Volatility and Exchange Rate in Zimbabwe

Abstract

Abstract In recent years, the amount of foreign equity investment inflows in Zimbabwe has decreased against the backdrop of an unstable and rapidly appreciating local currency. The aim of the study was to reveal the nexus among foreign portfolio investment, stock market performance and exchange rate in Zimbabwe from October 2018 to April 2022. The research utilized a package of hybrid multi-equation models including, vector autoregressive system to capture feedback relationships, EGARCH to incorporate asymmetric and volatility effects on stock performance and Granger causality to capture cause and effect dynamics. Impulse response functions and variance decompositions were employed to capture responses and innovations in the VAR system. Results revealed presence of short-lived volatility (implied risk) persistence, positive link between lagged market returns and foreign portfolio investment, inverse link between volatility of market returns and net foreign equity flows. On Granger causality, triangular linkages were revealed with unilateral causality emanating from foreign portfolio investment to stock market volatility (implied risk) to foreign portfolio investment volatility. Thus, it may be concluded that stock market volatility attenuated the relationship between foreign portfolio investment volatility and that relationship. Consequently, the study's empirical results has various policy ramifications. The investment community is recommended to buy assets at deep discounts and keep them for long-term wealth maximization in order to capitalize on the ZSE's transient volatility. In terms of policy recommendations, the Ministry of Finance is urged to reduce the withholding tax and capital gains tax on long-term stock and debt investors on the Zimbabwe Stock Exchange.