Effect of Inflation Rate on Stock Market Volatility in Frontier Capital Markets: a Case for Kenya Nairobi Securities Exchange

Abstract

Policymakers and investors have been closely monitoring the volatility of stock prices in the capital market, which has significant policy and practice implications to portfolio risk management, pricing of derivative securities and for portfolio diversification. A stable stock market is an ingredient to the financial sector stability of any economy. However, investors lose confidence in a highly volatile stock market because of the uncertainties that comes with it which erodes investor confidence negatively affecting its performance. At NSE, volatility of stock prices is a common phenomenon that instills fears to investors as certain drop in share prices may result to massive losses to investors. The volatility of stock prices makes it hard for investors to make concrete investment decisions on whether to invest in a particular firm or certain products and services. The purpose of the study aims at determining how inflation rate impacts stock market volatility wit focus to NSE. The general objective is supplemented by specific objectives that included determining the level of stock market volatility at NSE, determining of inflation effects rate on stock market volatility at NSE and to draw policy recommendations from the study findings. The theories that guided the study include fisher hypothesis, proxy hypothesis and inflation illusion hypothesis. Time series data covering the period 1990 to 2020 would be utilized and would be sourced from, WDI, Nairobi Securities (NSE) reports and Central Bank of Kenya (CBK). Eviews Software was utilized in analyzing the secondary data collected. The analysis of data entailed inferential and descriptive statistics. The Skewness and Kurtosis, maximum and minimum as well as means and deviations from the means formed the descriptive results. Inferential statistics entailed time series models to determine inflation rates effects on the volatility of stock market at NSE. The research conducted pre and post estimation tests that included stationarity test, heteroscedasticity tests, serial correlation and normality tests. The study concluded that throughout the period under review, there were variations in the stock market volatility. Furthermore, the correlation between stock price volatility and inflation rate was positive, moderately strong and statistically significant. Finally, the correlation between stock price volatility and inflation rate was moderately strong and statistically significant. A recommendation was made to the government via the monetary policy committee of the central bank ought to revise its interest rates less frequently and that the changes in the interest rates should be minimal. This would be significant in stabilizing inflation rates. In addition, the government ought to come up with policies including introduction of subsidies that would tames the rising prices of some products and hence tame the rates of inflation, which would subsequently stabilize the stock market.