An Empirical Investigation of the Relationship Between Selected Macroeconomic Variables and Stock Prices: Evidence From the Nairobi Stock Exchange

Abstract

The study was carried out to examine the relationship between selected macroeconomic variables and share prices proxied by NSE 20 share index, for the period covering 1987 to 2008. The hypothesis tested aimed at showing the relationship that exist between NSE 20 share index and exchange rates, inflation, interest rates, money supply and gross domestic product. Secondary data were used in the study obtained from different sources including publications from the World Bank such as International Financial Statistics (1FS)S, Central Bureau of Statistics, Central Bank, African Economic Consortium and various publications of the University of Nairobi. The data were regressed using the Error Correction Mechanism, due to non-stationarity. Results obtained showed that there is indeed significant relationship between NSE 20 share index and exchange rate, NSE 20 share index and inflation. Other variables used also indicated the existence of a relationship but the relationship was insignificant such as NSE 20 share index and interest rates, money supply and gross domestic product. Based on these results, the study recommends investor education, as they need to understand the relationship between the stock market and the entire economy. The government needs to ensure interest rates are stable and be careful in the application of monetary and fiscal policies. The NSE should also introduce options and futures so that it can be able to compete with the global financial market.