Abstract
This paper examined Market Micro-structure interrelations between Stocks, Bonds and Foreign Exchange Markets. The Study analyzed both unconditional correlation, dynamic relationship and volatility spillovers effects between the markets. The analysis used the asymmetric dynamic conditional correlation (aDCC) using Exponential Generalized Autoregressive Conditional Heteroskedastic model (EGARCH). Using monthly data from Kenyan market during the period January 2004 - June 2017, results indicate that there is significant market interactions and interlinkages and existence time varying variance correlation between any bivariate set in the three markets in Kenya. While, the conditional correlations are positive, the unconditional correlation reveal, a negative correlation between Foreign exchange markets and the Bonds as well as stocks. The study proposes policy makers like the government through treasury, capital markets authority (CMA) and Nairobi securities exchange (NSE) to encourage more Kenyan investors to invest in bond market by marketing the bond market through educational forums, conferences. For the Proposal to take effect, appropriate authorities should stabilize the Kenyan currency through monetary interventions.
Highlights
To analyze the bivariate linkages between markets, respective returns are first fitted with univariate exponential generalized ARCH (GARCH) (EGARCH) asymmetric dynamic conditional correlation (aDCC) is fitted in the second step
The parameters estimates for aDCC-GARCH (1,1) model for stock markets and Bonds show the α1 value of the shortrun persistence is positive and β1 of 92% of conditional correlation value depends on its previous one
The parameters estimates for aDCC-GARCH (1,1) model for stock markets and Foreign exchange show the α1 value of the short-run persistence is positive and β1 of zero implying that conditional correlation value does not depend on its previous values
Summary
Most financial markets (Capital Markets, Insurance, Banking and pension funds) in any part of the world have a very close relationship and as such maintain great synergies rather than tradeoffs. It’s not clear as to whether stocks and bonds move in the move in the opposite direction inverse relationship (proposition 1) or if they same direction direct relationship (proposition 2) Proponents of proposition 1 have a general feeling that equity markets rise when the economy is either doing well This means that most companies are making good returns on assets/ investments leading to better share valuations. On the contrary, when the stock prices tumble, investor confidence wear off, leading to withdrawal or selling of shares and convert back their cash to foreign currencies to a higher demand for foreign currency their appreciation Much of those who support the view above base their arguments on demand and supply. Increase in consumer Index (Prices) leads to inflation and this in effect leads to the possibility of interest rate increases as government regulates money supply This action in turn leads to higher bond yields. Studies that researched in this area include, Lace et al [14] and Ciner et al [15]
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