An assessment of the pricing efficiency of the Nairobi Stock Exchange after earnings announcements

Abstract

In an efficient stock market, share prices fully and quickly reflect all available information. This implies that no excess returns can be made from buying and holding a given stock after new information about that given company reaches the market, since that information is already reflected in current prices. But because conditions for a perfect market do not exist in the real world, efficiency can only be achieved in degrees. Emerging stock markets especially tend to exhibit high price volatility, and may therefore offer opportunities for high buy and hold returns to speculators. This possibility is inconsistent with the efficient capital market assumption. The Nairobi Stock Exchange in particular has witnessed certain cases of extreme price volatility, which point to the possibility of underlying inefficiencies. Such inefficiency can distort the true shareholder value in a stock. The purpose of this study was to determine the speed of price adjustment, and also the pricing efficiency of the Nairobi Stock Exchange market after earnings announcements. The research findings not only add to the continuing debate on the validity of the Efficient Market Hypothesis, but are also useful to investors and to the Capital Markets Authority as a market regulator. The study was guided by the semistrong-form sub-hypothesis of the efficient market hypothesis. Efficiency was measured by the speed of price adjustment after earnings announcements. The study targeted all the companies listed at the Nairobi Stock Exchange, but an already constituted sample of 20 companies was used. Data consisted of the closing prices of the sampled stocks on the day of announcement, and on the 1st , 3rd , 7th , 14th and 28th day before and after earnings announcements. Data was analysed quantitatively for excess returns using a single factor market model that is based on the Asset Pricing Model. The study found that excess returns were realised both before and after the day of announcement. Exces returns did not approach zero within the 28tlJ. day window, which means that it takes more than 28 days for excess returns to cease. There was also evidence of the market anomalies of overreaction and underreaction. The study concludes that the Nairobi Stock Exchange is not semistrong-form efficient.