Macroeconomic Determinants of Stock Market Returns in Kenya: 1993-2015

Abstract

Debate on the stochastic behaviour of stock market returns, the macroeconomic variables and their cointegrating residuals remains unsettled. There is also no unanimity in the nature of relationship between stock market returns and the macroeconomic variables. Furthermore, the moderating effect of events such as the 2008 Global Financial Crisis on the relation between stock market returns and the macroeconomic variables has attracted very little attention. The purpose of this study was to examine the stochastic properties of stock market returns, exchange rate, inflation rate, interest rate and their cointegrating residuals. The study also determined the relationship between the macroeconomic variables and stock market returns. It equally investigated the moderating effect of the 2008 Global Financial Crisis on the relation between the macroeconomic variables and stock market returns. The study used monthly data from the Nairobi Securities Exchange, Central Bank of Kenya, and Kenya National Bureau of Statistics from 1st January 1993 to 31st December 2015. It employed the Auto-Regressive Fractionally Integrated Moving Average to determine the integration orders of the variables and the cointegrating residuals. The study also used an Auto-Regressive Distributed Lag cointegration test to establish cointegration between the macroeconomic variables and stock market returns. An interaction modelling was adopted to investigate the moderating effect of the 2008 financial crisis on stock market returns with the data being split into pre-crisis period, crisis period; and post- crisis period. Results indicate that all the variables and the cointegrating residuals are fractionally integrated. This implies that shocks to them are highly persistent but eventually dissipate. It also suggests that when each of the macroeconomic variables is driven away from stock market returns, new and undesirable long-run equilibriums might be established if active policy interventions are not undertaken. Stock market returns lead interest rate and month-on-month nflation rate in the short run. This implies that a thriving stock market aids in realizing a macroeconomic stability. The macroeconomic variables are jointly cointegrated with stock market returns with both measures of inflation rate being positively related to stock market returns in the long run. This suggests that investors in the stock market are cushioned from rising inflation rate. A unit increase in exchange rate and inflation rate depresses stock market returns after compared to before the Global Financial Crisis. This implies that policymakers and stock market regulators need to be extra cautious when intervening in the activities of the stock market, especially after turbulences. This thesis is the first to empirically examine fractional cointegration between the macroeconomic variables and stock market returns in Kenya. It is also the first study to examine the moderating effect of the 2008 financial crisis on the relation between the macroeconomic variables and stock market returns in Kenya.