Inflation and stock market volatility in Kenya
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Date
2016-11
Authors
Gibet, Benard
Journal Title
Journal ISSN
Volume Title
Publisher
Kenyatta University
Abstract
The effect of inflation on the stock market has attracted many studies. Fisher theory
postulates that the real rate of returns on common stocks do not depend on inflation,
indicating that stocks should be independent of inflation. The studies have attempted to
investigate how inflation affects the stock market and the studies have mainly used the
aggregate stock market index. However, the use of aggregate indices may mislead on the
actual performance of sector-specific indices. The empirical studies using the aggregate
index across countries reveal mixed results. The negative and positive effect findings of
inflation on stock market contradict the Fisher hypothesis which states that stocks should
have a neutral relationship against inflation. In addition there was a difference in the effect
of inflation on stock market volatility across the sectors of the stock market. This study
investigated the effect of inflation on sector stock market volatility for Kenya Nairobi
Securities Exchange. The sectors at the Nairobi Securities Exchange were agricultural,
automobiles and accessories, the banking, commercial and services, construction and allied,
energy and petroleum, insurance, investment, manufacturing and allied, telecommunication
and technology sectors. Monthly secondary time series data, for the period 2006-2014, on
inflation price earnings, and Nairobi Securities Exchange Index were used in the analysis.
An empirical investigation on the effect of inflation on price earnings and Nairobi Securities
Exchange Index was conducted. This study used Autoregressive Distributed Lag Model
(ARDL) for sectors whose variables were stationary at levels. Johansen Cointegration Test
was used for sectors whose variables were non- stationary. In the latter, Vector Error
Correction Model (ECM) was used after confirmation of cointegration. In conclusion the
results indicated that inflation affects the automobile and commercial sector price earnings
ratio positively while in the short run the automobile sector, banking sector, commercial
sector, construction sector, insurance sector, investment sector, manufacturing sector
price earnings ratio are all positively correlated to inflation in the short run and in long
run. Inflation was negatively correlated to energy sector and agricultural sector. The
results indicated that inflation affects all sectors price earnings both in the long run and in
the short run. Inflation affects the entire stock market positively.
Description
Research project submited to the department of statistics and econometrics in partial fulfilment of the requirement for award of Master of Economics (Econometrics) Degree of
Kenyatta University. November, 2016