Effect of inflation on performance of Nairobi securities exchange 20 share index

Abstract

Inflation in Kenya has been unstable especially during the period of study. Increased inflation is associated with high cost of living thereby reducing amount available for investment. The government aims to maintain a constant rate of inflation characterized by a single digit. The aim has been to make inflation almost predictable and not sporadic as it has been in the Kenyan economy. Consumer Price Index (CPl) is used in measurement of inflation in Kenya. It is of concern to establish the effect inflation risk has on the shares market. The study had the objective of establishing the effect of inflation risk on the performance of the NSE 20 share index. The study used the NSE 20 share index to represent the performance of share market in Kenya. The index is the oldest and widely used share market performance indicator in Kenya. The study considered theories dealing with macroeconomic indicators including inflation. The study considered various theories on share prices including Portfolio Selection Theory, Capital Assets Pricing Model (CAPM) and Arbitrage Pricing Theory (APT) and evaluated empirical evidence from studies conducted in Kenya and around the world. The study also reviewed behavioural theories on investment including prospect theory and heuristic driven biases. The study used secondary data which was analysed through statistical tests. Monthly inflation data was obtained from Kenya National Bureau of Statistics (KNBS) while the monthly value of NSE 20 share index was obtained from Nairobi Securities Exchange (NSE). The aim was to establish a predictor model having the NSE 20 share index as the dependent variable and inflation as the independent variable. Analysis of the variables used the SPSS program to conduct tests on the data. Scatter diagram, descriptive statistics and simple regression models were used in the analysis. The best fit line on the scatter diagram indicated there is no relationship between the 2 variables. Descriptive statistics indicated that both variables are widely distributed with Inflation having a mean of 8.86 and standard deviation of 5.26 while NSE 20 share index has a mean of 3,534.04 and standard deviation of 1,204.9.The value of R squared is 0 meaning there is no relationship between the variables. The regression model developed is weak in predicting the NSE 20 share index value. The study recommends controlling of inflation rate to make it more predictable and create a favourable investment environment. The study further recommends investigation of the effect of inflation