1.1 BACKGROUND OF THE STUDY
Given the increasing trend towards globalization in financial markets, a substantial amount of research has been devoted to the investigation of the relationship between macroeconomic indicators and financial performance of insurance companies in Nigeria. Portfolio theory suggests that if the stock returns between markets are less than perfectly correlated, investors should be able to reduce their risk through international diversification. If countries stock returns are positively related, however, it is possible to sue the information in one market to predict the movement in the other market. The expected returns from the investment in foreign stocks are determined by changes in local stock price and currency values. If the effect of exchange risk does not vanish in well-diversified portfolios, exposure to this risk should command a risk premium. Therefore, the interaction between currency value and stock price is an important determinant of global investment returns (Dong et al, 2005).
Establishing the relationship between stock prices and exchange rates is important for a number of reasons. First, the link between those who markets may be used to predict the path of the exchange rate. This can have implications for the ability of multinational corporations to manage their exposure to foreign contracts and the exchange rate they face.
Classical economic theory hypothesis that stock prices and exchange rate can interact by the way of the flow oriented models, and portfolio balance models. Flow oriented models, first discussed by Dornbursh and Fisher 1980 that exchange rate movements causes movements in stock prices. This approach is built on the macroeconomic view that because stock prices represent the discounted present value of a firm expected future cash flows, then any phenomenon that affects a firms cash flow will be reflected in that firms stock prices if the market is efficient as the efficient market hypothesis suggest movements in the exchange rate are one such phenomenon.
1.2 STATEMENT OF THE PROBLEM
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