Test of the effect of macro-economic variables on volatility of securities prices: evidence from Nairobi Securities Exchange

Abstract

Volatility as the erratic rise and fall in the stock returns has alot of demerits especially when it comes to valuation of equities at the stock exchange in that it may cause the bourse to value the securities incorrectly, as well as act as a cold shoulder to investors confidence due to increased uncertainty and hence risk which subsequently may lead to limited investment as a result of the high capital cost emanating from high premium, demanded by shareholders in their investment, this will eventually lead to a slow growth and development of an economy. The main objective of this study is to establish the effect of macroeconomic variables on the volatility of securities prices in the Nairobi Securities Exchange (NSE). To achieve the objective of the study, models were developed using annual inflation rate, exchange rate, interest rate, money supply, broad money supply and general money supply as the independent variables and the stock returns as the dependent variable. An empirical analysis was conducted using Nairobi Securities Exchange (NSE) index as the population. The period of analysis was 22 years from 1st January 1990 to 31st December 2011 on annual basis. The correlation results reveal that exchange rate (EXR) has the highest negative impact on volatility of equity prices, whereas inflation rate (INF) had the lowest marginal impact and! or effect on volatility of security prices. Moreover, interest rate (INT) had a significant, negative impact on volatility of security prices. Others such as general money supply (GMS), money supply (M3) and broad money supply (M3X) had a higher positive effect on volatility of security prices. In our empirical analysis, by employing the EGARCH and TGARCH model we were able to deduce that the level and! or degree of volatility persistence, volatility magnitude and leverage effects to be in existence at the NSE but varied in terms of significance of the shocks impact on stock volatility, of each of the selected macroeconomic variables. However, collective impact was significant.