Effect of Inflation on Stock Market Returns at Nairobi Security Exchange

Abstract

The relationship between inflation and stock market returns has been investigated by several researchers around the world. The findings of investigations have recognized the existence of connection between stock market performance and inflation. However there has been various conflicting results. The specific objective of this investigation was to determine the influence that inflation has on returns of stock market at the NSE. The study utilised a descriptive case study research design covering a time period of seventeen years from 2000 to 2016. Further the study investigated the influence of money supply, real GDP, interest rate and exchange rate on the returns of stock market. Secondary data was acquired from the NSE for stock market returns while for inflation, money supply, exchange rate, interest rate and GDP was obtained from CBK and KNBS. The data was collected and analysed using Stata version 12.0 and the result of the analysis presented in tables. The correlation results revealed a strong positive correlation for the stock market returns and the CPI. The results for the Philips- Perron test for unit roots showed time series for returns of the stock market and inflation were stationary after differencing them once. ARDL long-run regression findings showed that there is a positive but insignificant connection of inflation and stock market returns. The findings also revealed negative long-run connection for the real exchange rate and stock market returns and between real rate of interest and the stock market returns. Positive long-run connection was found between real supply of money and returns of stock market and between real GDP and returns of stock market at the NSE. ARDL short-run results showed that inflation rate positively influences stock market return at the NSE. The results also showed that real money supply do have strong positive influence on stock market returns at the NSE. The rest of the variables, real exchange rate, real rate of interest and real GDP does not have any significant influence on stock market returns at NSE for the short-run. The investigation revealed that economic growth is the most important determinant of stock market returns in Kenya in the long-run. The study recommended that the government should ensure that there is a stable macro-economic environment which will ensure high economic growth rate in the country. This will enable high returns to the investors in the stock market and spur further growth in different sectors of the economy.