Cointegrating Relationship between Macroeconomic Variables and Stock Market Prices in Nairobi Securities Exchange

Abstract

The study of stock market prices movements and macroeconomic indicators has been imperative in view of the country’s economic growth because the most sensitive segment of any developing economy is its stock market. The buy and sell decision rule are affected by the investor’s psychology which exerts influence on the macroeconomic events. The very critical question when it comes to this is that how instantaneous the information is transferred to the investors and market analyst and in return reflects on stock market prices. Therefore, the purpose of this paper was to analyze cointegrating relationship between macroeconomic indicators and the stock market prices in the context of Nairobi Securities Exchange. The paper used longitudinal research design using monthly secondary data for the period 2005 to 2018. The data were sourced from NSE, KNBS and Central Bank of Kenya. Augmented Dickey Fuller test confirmed the presence of unit root at levels for some variables, and all the variables attained stationarity after first difference. The Optimum lag length selected was 3. Johansen cointegration test showed that the variables were cointegrated thus Vector Error Correction Model was used to estimate the parameters. The error correction term was -1.1804 and significant at p-value 0.000 indicating a long-term existence between variables and the stock market prices. Jarque-Bera test showed the residuals followed normal distribution. Inflation and interest rate negatively and significantly affected stock market prices at coefficient -0.8371 (p-value 0.005) and -4.0876 (0.000) respectively. However, Exchange rate and nominal GDP had positive and significant effects on stock prices at 0.0001 (p-value=0.012) and 0.00002 (p-value=0.000) respectively. It was recommended based on the findings that the government should adopt expansionary monetary policy to by regulating interest rate and stabilizing exchange rate to create more money for investors. There is need for the government to encourage activities that increases GDP since it is an important macroeconomic indicator for health economy.