Effect of Stock Market Development on Economic Growth: a Case of Nairobi Securities Exchange, Kenya

Abstract

Nairobi securities Market has not been performing to the expectation of many Kenyan investors. The weak management has manifested itself after the collapse of two stock brokers almost at the same time. This happened in 2008 and 2009 causing a lot of anxiety among the individual investors As a result there has been under subscription of initial public offer and right issues for instance in the case of Cooperative Bank of Kenya, British American Insurance and Kenya airways. This is a clear sign of deterioration in performance and loss of goodwill in this important institution. The main objective of the study was to investigate the relationship between stock market development and economic growth. Stock market development indicators were market capitalisation, total shares traded and equity turnover. The specific objectives were to examine the effect and direction of stock market capitalisation on economic growth, to determine the effect of total value of shares traded on economic growth, to establish how the equity turnover in the securities market had influenced economic growth and to examine the effect of investment and university enrolment on economic growth. The study carried an empirical investigation using quarterly time series data for the period 1996 to 2010, to establish the short run and long run effects of each indicators of stocjc market development on economic growth. The study adopted the Harrod-Domar growth model and used the Ordinary Least squares (OLS) Method to estimates the effect. ECM was used to (estimate the short run dynamics. The short run analysis revealed that investments, market capitalisation and equity turnover had positive effect on economic growth while total value of shares traded, equity turnover and university enrolment had positive effects on economic growth in the long run. The result implies that it is pertinent to increase investment within the economy because in the short run investments showed a strong and positive relationship with GDP. More investment in the economy means higher capital formation. High capital formation in turn calls for human capital to be in place for it to be fully utilised depending on the level of technology employed by the economy In addition, the results showed that there was a positive long run relationship between human capital and GDP. The market capitalization showed little effect on economic growth either in long run or short run. This means that market capitalisation is not a good indicator for stock market development. The total shares traded revealed a strong and positive impact on economic growth in long run, while equity turnover showed that it impacted positively on economic growth in both the short run and long run although its coefficient was not statistically significant. The study concluded that more coherent effort from the government towards developing Nairobi Securities Market is required and should be particularly geared towards improving stock market developing indicators like investments, market capitalisation, turnover, total shares traded and human capital development. This can be done through public awareness on the importance of saving and investments, incentives for companies to be listed in NSE, reducing transaction cost at NSE, investing on human knowledge and skills on securities. This is because stock market development indicators have positive effects on economic growth.