Systematic Risk and Performance of the Stock Market in Kenya

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Mutwiri, Nathan Mwenda
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Kenyatta University
Stock prices in Kenya have been experiencing drastic volatility in the recent past. In the year 2015 alone, the value of the listed companies shrunk by about Ksh 250 billion representing about 25% of the national government annual budget. Performance of stock market is an important proxy of a country’s economic environment. Globally, economists, financial analysts and investors are interested in comprehending the factors that affect the fluctuations of stock markets. When the stock markets operate smoothly and efficiently, they facilitate economic growth and lower business risk. Excessive fluctuations of stock prices (in the financial markets) affects the smooth operation of financial markets and consequently adversely affects the performance of an economy. Rational investors are keen in achieving their maximum expected rate of return of their investments including stocks; they constantly value and revise their portfolio composition so as to maximise their wealth. An effectively diversified portfolio minimises the unsystematic risk hence almost eliminating these risk associated with an individual asset. However systematic risks cannot be managed by simple diversification. Investors therefore need to understand the effect of these systematic risks on the stock performance. The study sought to determine the relationship between systematic risk factors and performance of the stock market in Kenya. The specific objectives of the study were: to establish the relationship between Interest Rates, Foreign Exchange Rate, Inflation, Gross Domestic Product, Trading volumes and Performance of stock market in Kenya. The study adopted a positivist philosophy and employed a correlation research design. The study targeted all the stock listed in the Nairobi Securities exchange. This study utilized the NSE 20 share index movements to measure the performance of the stock market in Kenya. The study was underpinned by the Efficient Market Hypothesis, Capital Asset pricing Model, Arbitrage Pricing theory, Keynesian theory and Mixture Distribution model as theories and models anchoring the study. The study investigated the long run and the short run relationships between the systematic risks and performance of stock markets in Kenya using ten years (2007 to 2016). The study used time series secondary data from the Central Bank of Kenya, Kenya National Bureau of Statistics and the Nairobi Securities Exchange. The study used cointegration analysis to establish the relationships between the variables of study. In addition Johansen-Julius test of cointegration, Vector Error Correction Model and Granger causality test were used to test the relationships. The study found a significant long run positive relationship between interest rate, exchange rate, inflation, gross domestic product and performance of the stock market in Kenya. The study found a negative significant relationship between commercial bank weighted average lending rate, the trading volumes and the Performance of Nairobi Stock exchange. Growth in Gross Domestic Output was insignificant in explaining the performance of Nairobi stock exchange. In the short run, only three lags of commercial bank weighted lending rate, one lag of Inflation, and three lags of Trading volumes were significant in explaining changes in Nairobi stock exchange. This is an indication that C.B.K should not be keen to increase the CBR because this leads to a decline in stock prices and this discourages potential investors away which is disastrous for the economy. Additionally, the central bank should not be keen on having a target exchange rate for the USD/Ksh because changes in exchange cannot significantly explain the changes in stock price hence such a move would not be very effective. Investment firms, financial analyst should use past data on 91 Treasury bills rate, Inflation, Trading volumes to predict future performance of stock exchange for the benefit of investors.
A Thesis Submitted to the School of Business in Partial Fulfilment of the Requirements for the Award of Degree of Doctor of Philosophy in Business Administration (Finance) of Kenyatta University,June, 2019