A Test of the Effect of Macro-economic Variables on Volatility of Securities Prices: Evidence from Nairobi Securities Exchange

Abstract

Volatility as an erratic rise and fall in the stock returns with a lot ofdemerits especially when it comes to valuation of equities at the stockexchange in that it may cause the bourse to value the securitiesincorrectly. All it may act as a cold shoulder to investors confidencedue to increased uncertainty and hence risk which subsequently maylead to limited investment as a result of the high capital cost emanatingfrom high premium, demanded by shareholders in their investment. Thiswill eventually lead to a slow growth and development of an economy.The main objective of this study is to establish the effect ofmacroeconomic variables on volatility of securities prices in the NairobiSecurities Exchange (NSE). To achieve the objective of the study, modelswere developed using annual inflation rate, exchange rate, interestrate, money supply, broad money supply and general money supply asthe independent variables and the stock returns as the dependentvariable.An empirical analysis was conducted using Nairobi SecuritiesExchange (NSE) listed firms as the population. The period of analysiswas 22 years from 1 st January 1990 to 31 st December 2011 on anannual basis. The correlation results reveal that exchange rate (EXR)has the highest negative impact on volatility of security prices, whereasinflation rate (INF) had the lowest marginal impact and/ or effect onvolatility of security prices. Moreover, interest rate (INT) had asignificant, negative impact on volatility of security prices. Others suchas general money supply (GMS), money supply (M3) and broad moneysupply (M3X) had a higher positive effect on volatility of security prices.In our empirical analysis, by employing the EGARCH and TGARCHmodel we were able to deduce that the level and/ or degree of volatilitypersistence, volatility magnitude and leverage effects to be in existenceat the NSE but varied in terms of significance of the shocks impact onstock volatility, of each of the selected macroeconomic variables.However, collective impact was significant.