The relationship between macroeconomic variables and share prices of companies listed at the Nairobi Securities Exchange

Abstract

The study was carried out to examine the relationship between macroeconomic variables and share prices of companies listed in Nairobi Securities Exchange as proxied by NSE 20 share index, for the period covering 2002 to 2012. Macroeconomic variables include GDP, inflation, exchange rate and interest rate analyzed using annual data covering the period 2002 to 2012. Secondary data was used in the study and obtained from different sources including publications from the World Bank such as International Financial Statistics (IFS), Central Bureau of Statistics, Central Bank and various publications of the University of Nairobi. The study first found it necessary to determine the trend of share prices for the year 2002- 2012. This was to determine the overall share price performance as a result of the economic situation in the country over a range of time period. From the study findings, it is construable that in first seven years from 2002 to 2008 the share index showed upward trend. But in 2009, due to uncertainties it showed a downward trend but after that period, the trend goes upward again. The positive upward trend is as a result of stability in macroeconomic variables under consideration i.e. interest rate, gross domestic product, exchange rate and inflation rate. The study also shows that share prices are affected by macroeconomic variables and this implies that macroeconomic variables GDP, INT, INF and EXR are very crucial in determining share price index in an economy. From the Correlation coefficients results, GDP, INT, INF and EXR posted a positive relationship with the share prices. Also. The correlation matrix indicates that gross domestic product is highly and positively correlated with share price index as well as interest, inflation and exchange rates. Logarithm of real values was used to reduce the statistical figures in to meaningful values for easy interpretation. The use of the natural log also reduces the heteroskedasticity and also provided a better fit for outliers within the distribution. With these results, it is important that monetary managers should adopt suitable monetary measures to control inflation, so that the volatility of the share market can be reduced. The increase in Gross Domestic Product can play significant positive role in development of the capital market. Policy makers need to be careful too when trying to influence the

economy through changes in macroeconomic variables such as interest rate as this may inadvertently depress the stock market and curtail capital formation which itself would lead to further slowdown of the economy.