Reversals of foreign portfolio equity due to a shift in investor risk appetite may have a drastic impact on the value of shares of commercial banks hence the effect on stock returns. Uncertainties in the flow of foreign portfolio investments (FPI) result in unpredictable behaviour of stock returns in Kenya’s economy and also at the firm level. The objective of this study was to find out the effect of foreign portfolio equity and exchange rate risk on stock returns of listed commercial banks in Kenya. The target population of the study was 11 commercial banks listed on the Nairobi Securities Exchange. The study used purposive sampling technique and concentrated on 10 commercial banks. This study used a causal research design and adopted a panel data regression using the Ordinary Least Squares (OLS) method where the data included time series and cross-sectional. Hausman test was carried out and findings indicated that random effects model was preferable for this study. Results from panel estimation showed that exchange rate risk affect stock returns of listed financial institutions in Kenya. The study recommended that policies that would attract foreign portfolio investment should be pursued by commercial banks in order to enhance stock returns.
Key words: Foreign portfolio equity, stock returns, exchange rate risk, commercial banks, Nairobi securities exchange, Kenya.
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