The relationship between stock returns and bond returns in the Nairobi Stock Exchange

Abstract

Capital markets represent a fundamental element of the financial system of any modem economy and they play an important role in the allocation of capital within the economy. Therefore public authorities responsible for economic policy as well as private sector agents who are active in the capital markets have a vested interest in capital markets that are both efficient and stable. The availability of financial capital is a prerequisite for development and transformation of any nations economy hence many African countries have invested in developing capital markets as institutions for mobilizing external capital inflow and domestic savings. The development of domestic capital markets provides an opportunity for greater funds mobilization, improved resource reallocation and provision of relevant information for investment appraisal (Black et al 1988). The Kenya stock market just like many developing countries is an important avenue for resource mobilization in terms of savings mobilization and resource allocation. How well the stock market plays its role of saving mobilization and efficient resource allocation will depend on how well the investors perceive the performance of the economy as indicated by the index. The study looks at the relationship between stocks returns and bond returns for the period 1999 to 2003. It also utilizes the method of correlation coefficient to determine the relationship between the movement between the stock and bond returns. Bond returns are categorized as corporate, government fixed, and government floating. A comparison is also established between average of government bonds and average of all bonds. The relationship between stock returns and individual bond returns is found to be insignificant within the year however over the years there is a very strong negative relationship, which means that in the short run there is no significant relationship however in the long run the relationship is negative and very strong as measured by the coefficient of determination. The study shows that bond returns explain stock returns in the long run.