Dynamic relationship between macroeconomic factors and equity market price at Nairobi securities exchange, Kenya

Abstract

The Nairobi Securities Exchange is one of the emerging markets in the East African region and has seen consistent growth over time. The Exchange has stood out as an average Exchange with great potential for growth, however, in the period between the years 2000 and 2013, the share prices of firms listed at the Nairobi Securities Exchange experienced turbulence in the equity prices that led to investors losing billions of their investments in the portfolio. This study sought to explore the dynamic relationship between selected macroeconomic variables and equity prices in Kenya. Specifically, the study sought to establish long run and short run dynamic relationships between selected macroeconomic variables and equity price. The independent variables in the study were Treasury bill rate, consumer price index, gross domestic product, money supply and exchange rate, political environment, terms of trade and public debt and on the other hand, equity price was identified as the dependent variable. The data was collected from Nairobi Securities Exchange, Central Bank of Kenya, Kenya National Bureau of Statistics and Capital Markets Authority using data collection schedules. Particularly, data on NSE20 Share Index was obtained from the Nairobi Securities Exchange while data for the other variables were obtained from Central Bank of Kenya and the Kenya National Bureau of Statistics. Autoregressive Distributed Lag model was employed to analyze fourteen-year quarterly time series data for the period between 2000:1 and 2013:4 with the help of E-views software. Further, variance decomposition and impulse response function was run. First, diagnostic tests were conducted on the model to test the suitability of the model. The results of the test revealed that the model did not suffer from non-normality, heteroskedasticity, serial correlation and misspecification and hence the model was suitable for this analysis. The results of bound test revealed that there was a joint significant long relationship between selected macroeconomic variables (gross domestic product, public debt, consumer price index, money supply, exchange rate, political risk, terms of trade and Treasury bill rate) and equity prices. Further, short run dynamics was determined using error correction model. This indicated that the speed of adjustment from disequilibrium in equity prices in the previous period in the prevailing period was at 56.6%, which was quite high. The high speed of adjustment suggested a quick reaction of the market to information. In addition, variance decomposition and impulse response function showed that one standard deviation positive shock on gross domestic product, money supply, political risk and exchange rate negatively affected the equity price and standard deviation positive shock on public debt and lagged equity price positively affected equity price for firms listed at the Nairobi Securities Exchange. Based on the results of the study, it is recommended that the government of Kenya should put in place appropriate policy measures to ensure that the exchange rate is stabilized among measures that stimulate the economic growth. Further, the government should put in place measures aimed at reducing political risk in the Kenya.