Investment Intensity Risk, Investor Irrationality and Stock Returns in Kenya

Abstract

The purpose of this paper is to investigate the effect of investor irrationality on the relationship between investment intensity risk and stock returns in Kenya.The study utilized monthly time series data for 60 companies listed at the NSE over the recent 9 years from 2011-2019. The study employed time series regression using Auto-Regressive Distributed Lag (ARDL) cointegration approach and Error Correction (ECM) estimation techniques to examine whether the effect of investment intensity risk on stock returns will vary with level of investor irrationality. Consistent with theory, investment intensity variable had more positive loadings on small firms with conservative investment policy, implying they have high exposure to investment risk and tend to yield higher returns. The study did not find evidence to support investment intensity risk in Kenya. The Investor irrationality variable is however a significant source of systematic risk and can enhance the predictive power of asset pricing models. The interaction term between investor irrationality and investment intensity was insignificant suggesting lack of moderating effect.The shorter nine year period considered by the study could be a source of small sample bias in the estimation. Sample periods for studies in mature markets span for over decades. In this light, making comparison of the findings in this thesis with those of other related studies may not be feasible. This study is first of its kind to analyze the moderating effect of investor behavior on asset pricing for an emerging market. The paper contributes to portfolio management and asset pricing literature for an emerging market.Practical implication of the findings in this study is that investments at NSE will yield high returns in a bullish market and that portfolio managers can strategically build up their portfolios to allocate more funds in small firms following conservative investment policy to earn higher risk-adjusted returns.