Effects of the Volatility of Selected Macroeconomic Factors on Stock Market Returns in Kenya

Abstract

The stock markets play a vital role in the development of the economy in a country by acting as a platform to raise business capital, mobilize savings, control the management of firms, and to raise government capital. The performance of the markets is influenced by different factors among them being macroeconomic factors. This study sought to determine the effects of the volatility of selected macro-economic factors on the stock market returns in Kenya, with a key focus on interest and foreign exchange rate volatility. The study used the NSE 20 share index to determine the stock market returns, the interbank rate to proxy interest rate and the USD/KES for the foreign exchange rate. Panel data from January 2009 to December 2018 was used and daily observations were applied. The study was based on the Markov switching model. The results indicated that during the period under study, there were three regimes characterized as low, medium and high volatility regimes. The longest regime was the moderate volatility regime followed by the high volatility regime. The shortest regime was the low volatility regime. During the high volatility regime, the stock returns followed a random walk with little levels of predictability. In the moderate volatility regime, the historical performance was positively correlated to the stock market returns, while there was no significant effect of the volatility of interest and foreign exchange rates on the stock market returns. The period of low volatility was characterized with significant positive and negative effects of the foreign exchange and the interest rates, and the historical performance on the stock market returns. Based on the results, the study found out that the effects of the volatility of the interest rate and foreign exchange rate differ depending on the distinctive volatility regimes.