The Effect of Inflation on Stock Market Returns at the Nairobi Securities Exchange

Abstract

The causal nexus between inflation and stock market performance has received considerable attention from academicians where studies have used data from both developed and developing countries. Extant research works have documented the adverse costs of inflation on various parts of the domestic economy. Still lacking is conclusive validation of how changes in inflation affect stock market returns besides linking this evidence to specific firms. This study sought to determine the effect of inflation rates on stock market returns at the NSE. The independent variable was inflation rates as measured by monthly CPI. The control variables were exchange rates as measured by monthly exchange rate between KSH and USD and interest rates as measured by monthly CBK lending rate. Stock market return was the dependent variable which the study sought to explain and it was measured by monthly returns computed from the 20 share index. Secondary data was collected for a period of 10 years (January 2007 to December 2017) on a monthly basis. The study employed a descriptive research design and a multiple linear regression model was used to analyze the association between the variables. Statistical package for social sciences version 21 was used for data analysis purposes. The results of the study produced R-square value of 0.113 which means that about 11.3 percent of the variation in stock market returns at the NSE can be explained by the three selected independent variables while 88.7 percent in the variation was associated with other factors not covered in this research. The study also found that the independent variables had a weak correlation with stock market returns (R=0.337). ANOVA results show that the F statistic was significant at 5% level with an F statistic of 4.949. Therefore the model was fit to explain stock market returns at the NSE. The results further revealed that individually, inflation rate and exchange rates are statistically significant determinants of stock market returns at the NSE while interest rate is not a significant determiner of stock market returns. This study recommended that policy makers should pay attention to the prevailing rates of inflation and foreign exchange rates as they can negatively affect stock market returns recorded at the Nairobi Securities Exchange.