Trading volume behavior and its effect on stock price movements at the Nairobi stock exchange

Abstract

In a perfectly efficient stock market where there are many small buyers and sellers each having equal access to information and where there are no transaction costs, security prices change (at any moment in time) only in response to new information about the expected return of the security or about its riskiness. The security prices reflect both company-specific and macroeconomic fundamentals and are not susceptible to forces which have little or nothing to do with the underlying value of the company. Trading volume behavior should not contribute to significant changes in stock price volatility. This paper presents an empirical analysis of the relationship between trading volume and stock price movements at the Nairobi Stock Exchange. Research was carried out on 20 securities for companies that constitute the NSE 20 Share Index that remained listed at the NSE and traded over five year period under study (2002-2006). The study used T-test, F-test and correlation coefficients to determine whether there exists a relationship and the degree of association between trading volume and stock price movements. Value weighted average prices (VWAP) were used to construct the weekly closing prices for stocks while daily volumes were used to construct weekly volumes data. The sensitivity of stock price changes to trading volumes was derived by computing the percentage change in prices in relation to percentage change in trading volumes. Correlation coefficient was used to determine whether in overall, there exists an association between trading volumes and the security prices hence an indication of stock market inefficiency. The findings reveal that there is no significant association between the trading volumes and security market prices at the NSE. The study however indicates that large capitalization portfolio of securities exhibit higher price-to-volume correlations as opposed to small capitalization portfolio of stocks constituting the NSE Share Index. Statistical tests performed also indicate that this association is not significant enough to imply that any considerable stock market inefficiencies are as a result of stock liquidity and/or excess liquidity. However, correlation coefficients reveal that the association has been strengthening over the years. This may be explained by the exponential business activity at NSE and increased demand for shares may be exerting pressure on stock prices.