The Relationship Between Short Interest Rates and Stock Returns in the Nairobi Securities Exchange

Abstract

Among the most notable developments have been the establishment and revitalization of stock markets in emerging economies; and the shift from fixed exchange rates towards independently floating exchange rates. Though some stock markets in emerging economies have been performing exceptionally well (IFC, 1993), most of them tend to be very small in size, with very low volume of transactions. Stock market return has been a concern in the financial sector around the world. Stock markets in emerging market especially in African has gained prominence since the market has developed a step further to risk diversification apart from the primary role of providing an alternative source of capital for investment. This has been attributed by short interests which largely contribute to the stock market returns (Adam, & Tweneboah, 2008). To establish the relationship between short interest rates and stock returns in Nairobi Securities Exchange. The research design to be used in this study was both cross sectional and descriptive survey method. The target population consisted of all the stocks listed at NSE as at December 2012 from which NSE share index was derived from. This was a census study where all firms listed at Nairobi Securities Exchange from 2008 to 2012 were included. The data set consists of monthly observations of the closing price index and interest rates in the stock markets. Time series secondary data was used in the study. Monthly data on the Nairobi Securities Exchange Index was obtained from the Nairobi Securities Exchange. The data analysis entailed entering the data in SPSS (21.0). Linear relationship between the dependent and the independent variables was determined through panel approach for the regression analysis and inferences were drawn based on the regression analysis. The study found out that, interest rates positively influenced the stock returns at the NSE. The stock market’s reaction to real economic variables. Stock returns were found to be positively related with interest rate. The link between movements in interest rates and industry equity returns is weak at the shortest scales, but it becomes stronger at longer horizons corresponding to low frequencies. The study recommends the stock authority to focus on increasing the interest rates of the NSE. The evidence presented in this study may be very helpful for the assessment of potential sector-based diversification opportunities by investors, for the design and implementation of adequate interest rate risk management strategies by firm managers and investors, for asset allocation decisions by portfolio managers and for the formulation of appropriate monetary policy measures by governments.