Analysis of Systemic Risk Among Asset Prices Movement, Financial System and the Real Sector Economy in Kenya
Makambi, Steve Anyona
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The global economy enjoyed a period of low inflation and growth during the great moderation period in mid-1980 to 2006. However, prevalence of financial crises during and immediately after the great moderation period led to the realization that asset price movement was central to financial system stability. Second, it was discovered that pursuance of monetary policy does not guarantee financial stability. In this regard, there was great uncertainty as to the policy instrument needed to safeguard financial health in the economy. Safeguarding financial stability encompasses analysis of systemic risk factors that causes turmoil in the financial and real economic sectors. Systemic risks consist of all potential risk in the economic system that may negatively affect proper functioning of the economic system. In this regard, this study sought to analyze systemic risk among asset prices movement, financial system and the real economy. Specific objectives include: (i) to analyze the systemic risk in security asset prices movement in Kenya; (ii) to analyze the systemic risk in housing asset prices movement in Kenya; and (iii) to investigate the relationship among financial risk, asset prices movement and real sector economic variables in Kenya. To address the first and second objectives, three variants of consumption-based capital asset pricing model (CCAPM) are used. These include the standard CCAPM model, habit formation CCAPM model and Two-goods CCAPM model. To address the third objective, a macro-financial model was specified and included asset prices movement, credit risk and real economy variables. Quarterly time series data from 2001Q1 to 2017Q3 was used for analysis. The macro-financial model was estimated using VAR-X model. The main findings show that consumption risk factors such as changes consumption growth, habit formation and growth of durable goods were important in determination of security and housing asset prices movement. It was further established that while Kenyan investors make asset pricing decision with the objective of smoothening lifetime consumption, they exhibit low risk aversion behavior, and this was more pronounced in the housing market. However, there was evidence to show that risk aversion increases during bad economic times. Analysis of the relationship among financial risk, asset prices movement and the real sector confirmed existence of feedback loop between the asset market and real sector of the economy on one hand; and feedback effect between real sector variables and financial risk in the Kenyan economy on the other. It was further established that financial risk is was countercyclical to business cycles and tend to increase during recession and reduce during boom periods. Based on these findings, the study concluded that while low risk aversion maybe an indication of low systemic risk in the Kenyan market evidence of adjustment of risk during recession emphasizes the need for constant monitoring of systemic risk in the asset market. In addition, existence of feedback loops among macro-financial variables and enhances the need to adopt systemic risk management policies. The main study recommendation include designation of a macroprudential authority within Central bank with clear structures and mandate to constantly monitor systemic risk in the economy.