BBSE Research projects (2017)

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An assessment of the interest rate channel on monetary policy transmission in Kenya 2006-2015
(Strathmore University, 2017) Siele, Daisy Chepng'eno
For the government to achieve its desired level of economic growth, appropriate monetary policy needs to be formulated and implemented. Theoretical and empirical literature highlights the importance of the interest rate channel. However in Kenya there have been inconclusive evidence on the effectiveness of this channel. This study attempts to investigate the effectiveness of the interest rate channel of monetary policy transmission in Kenya during the period 1996-2015. The study employed Vector Autoregressive Models. The paper also employs time series techniques namely Unit root tests, cointegration, impulse responses and variance decomposition. Cointegration tests showed the presence of 2 cointegrating equations and the study proceeded to use Vector error correction models (VECM). From the impulse response tests, the interest rate channel of monetary policy is proved to be effective since the Central bank rate (CBR) is able to transmit effects on output and prices but its effectiveness is with the four lags for CPI and three lags for GDP. The forecast error variance decomposition show that in forecasting CPl, all fluctuations were attributed to itself, with decreasing significant contribution from CBR in the long run. Forecasting GDP showed that GDP fluctuations were greatly denominated by itself, however in the long run there was significant contribution in the other variables. The results show that the interest rate channel of monetary policy transmission is effective in Kenya.
A Comparative Study of Crank-Nicolson scheme and Monte-Carlo Option Pricing
(Strathmore University, 2017) Musahara, Angel Herman
This study examines the rate of convergence and the accuracy of the two primary option pricing methods used currently by professionals; Monte-Carlo and Crank-Nicolson scheme using the Black-Scholes price as the benchmark price. We also introduce the Antithetic variates to the Monte Carlo, to check how much the technique improves the accuracy of the model. A model that converges faster and is accurate will be important in the valuation of large number of options, this will be beneficial to the current and potential investors dealing with large number of options, usually this is the case in practice. Similarly, by control variates technique, we can use our result to improve the accuracy of pricing options that do not have closed form solution such as American options or other exotic options.
The consistency of credit risk pricing in emerging market sovereign debt: the relationship between Bond prices and credit default swap spreads
(Strathmore University, 2017) Kamau, Isaac Muturi
Theoretical foundations indicate that, under no-arbitrage conditions, a relationship between bond prices and Credit Default Swap prices should be observed. This study examines whether this relationship is evident in emerging market sovereign debt. By performing Johansen cointegration analysis on the debt spread and the CDS premium, mixed evidence is found: a relationship exists in some time periods but not in others. This implies inconsistent pricing of credit risk in some periods and is in line with previous empirical studies. Therefore, there exist opportunities for credit risk arbitrage although profits from these opportunities may be restricted by the limits to arbitrage. In addition, the effect of bond market volatility on the relationship between the debt spread and the CDS premium in analysed. It is found that volatility due to idiosyncratic factors does not affect the existence of the relationship. Finally, a qualitative analysis of the behaviour of credit risk in light of economic and political conditions provides some insights for macroeconomic policy makers in emerging market economies. Potential extensions to this study include empirical analysis on a different sample of sovereign emerging market securities and extension of existing credit risk pricing models.
Construction of multidimensional poverty index of Kenya using the Alkire-Foster method
(Strathmore University, 2017) Mukui, Joy Wamaitha
In this paper, we use one specification of the Alkire-Foster approach, which is referred to as the Multidimensional Poverty Index (MPI), to calculate the poverty index of Kenya. This index was computed for 104 countries in Alkire and Santos (2010) and launched as a prominent feature of the annual United Nations Development Program (UNDP). Human Development Report, replacing the previous Human Poverty Index of the United Nations Development Program. The novelty of this paper is that it seeks to reconstruct the poverty index which is used in Kenya’s Revenue Allocation formula. Currently, the country is using a modification of Human Development Index as used by UNDP which gives weights to different aspects of deprivation, a method that has been dubbed as ‘Lucy’s model’, named after the person who developed it in December 2015, and was approved for use by the Commission for Revenue Allocation to distribute funds from the National government to county governments, by the National Assembly of Kenya on 10th March 2016. The paper compares the allocations arrived at by both Lucy’s Model and Alkire-Foster method in terms of equality of means, variances, correlations and other statistical tests of significance in differences between two or more data sets.
Determinants of foreign direct investments in developing countries: evidence from Kenya and Nigeria
(Strathmore University, 2017) Mithamo, Magdalene Muthoni
Foreign direct investment has a direct relationship with technological change, public policy and level of economic activity. However, in some countries with unfavorable conditions such as high levels of corruption and diseases; foreign direct investment thrives despite this. This study investigates the determinants of foreign direct investment in developing economies using the cases of Kenya and Nigeria. The reason for the choice of these two countries is because of their odd foreign direct investment trends. The purpose of the study is not only to investigate the determinants of foreign direct investment in both countries, but to also enable the comparison of the determinants. The different methodology employed include: the use of the Vector Autoregressive model, Impulse response functions, Granger causality, Variance Decomposition, and the Ordinary Least Squares regression. The period of study is from 1970 to 2014 with the dependent variable being foreign direct investment and the independent variables being: growth in Gross Domestic Product, Exchange rate, inflation, Balance of Trade, growth in exports and trade openness. The findings of the study were that the most significant determinants of foreign direct investment in Kenya were exports and trade openness while in Nigeria the most significant variables were found to be inflation and trade openness as well.
Determining if Kenya’s foreign debt portfolio management is optimal
(Strathmore University, 2017) Sigey, Mercy Chepkoech
The study seeks to define Kenya's optimal external debt portfolio. The optimization scheme employed minimizes foreign liabilities in a foreign debt portfolio which includes a combination of foreign assets and liabilities of the country in question, which in this case is Kenya. It will involve comparing the optimal foreign debt portfolio with the currency exchange rates. The time series data that will be used consists of exchange rate data for the period from 1970 to 2016 and the percentage of external long-term public and publicly guaranteed debt share contracted in Japanese yen, Swiss Franc, U .K pound sterling for Kenya. The study will apply the cointegration methodology where it involves first carrying out unit root tests on the data to find out whether it is stationary. Thereafter, introduce the cointegration tests which will be used to form the results and discussions of this study. Ideally, a debt portfolio will be deemed optimal if movements in the exchange rates do not granger cause changes in the debt shares denominated in the corresponding currency.
The effect of stock price volatility on bank loan dynamics: a case of Kenya
(Strathmore University, 2017) Mwaura, Kenneth Ndung’u
The study seeks to evaluate dynamic linkages between stock prices and bank lending behavior prevalent in Kenya. As such the focal variables are loans to the private sector and share prices. However, because of the existence of common macroeconomic cyclical factors that may drive both variables, the study also uses other control variables i.e. price level (CPI), exchange rates and interest rates (interbank lending rates). The study employs the use of a VAR model with monthly data collected from the year 2005 to 2016. A unit root test and a cointegration test to check for stationarity and cointegration among variables respectively are also used. The findings are useful in explaining whether there is a causal relationship between adverse share price movement and bank lending in Kenya.
Effects of election years in Kenya on performance of shares at the Nairobi securities exchange in Kenya: the mediating role of market
(Strathmore University, 2017) Njoroge, Michael Njiraini
The Efficient Market Hypothesis is a core theory which explain s how the securities markets work. Itv proposes that capital markets are efficient to varying degrees where in this context, the term efficient means that the price of a share reflects information that pertains to the company (Fama, 1969). There are two types of investors, those who can consistently make above average returns and the other, those who lose their money due to unfavorable movements in the market. According to (Fama, 1969) market players can 't earn an above average return on their investment from information trading as long as markets are efficient, where information trading is making investment decisions based on information acquired on various securities. This gives rise to phenomena which can't be explained by EMH. Examples are 'day of the week' effect and 'month of the year" effect which shows that on certain days, returns are lower than on others. (Gao 2005) shows that an investor making decisions based on such phenomena could very well earn abnormal returns
Equity Investment Analysis, the case for a private university endowment
(Strathmore University, 2017) Njoroge, Linda Njeri
The purpose of this study is to investigate the assertion that university and college endowments should maintain one hundred percent equity holdings in their portfolios. An equity portfolio is compared to a traditional 60/40 stock-bond portfolio in testing this assertion. The focus is on the Kenyan stock market and the Nairobi Securities Exchange (NSE) All Share Index (NASI) is taken as a representative diversified equity market portfolio. A fifteen-year Kenyan infrastructure government bond is taken to represent the bond portfolio. The study considers whether the returns generated would sustain an endowment both in the short term (less than ten years) and in the long term (more than ten years). The study finds that equity returns are indeed sufficient to fund the endowment portfolio both in the long-run and short-run, but a traditional 60/40 portfolio is seen to have a higher risk-adjusted return.
An evaluation of entrepreneurship education as a tool used by the government to promote growth and development of SMEs in Kenya: A case study of the KPMG top 100 SMEs
(Strathmore University, 2017) Mukui, Pauline Njambi
The primary aim of this was to evaluate entrepreneurship education as a government policy tool, to stimulate growth and development of SMEs in Kenya. The SMEs considered for this study are all considered the best in their fields according to KPMG’s Top 100 SMEs. The study focused on owners or management of the SMEs selected. The study investigated whether entrepreneurship education had an effect on the performance of the selected KPMG Top 100 SMEs and subsequently their growth and development. The study made use of the data collected through the use of self-administered questionnaire in a survey. The data analysis included descriptive statistics and the T-test. Results showed a positive impact on the performance of SMEs in Kenya through the study of KPMG's Top 100 SMEs in 2015.It particularly improved entrepreneurship skills and knowledge of both the owners and managers of SMEs. The study indicated the extent to which entrepreneurship education plays in the growth and development of SMEs through highlighting the positive relationship between entrepreneurship education and growth and profitability of SMEs.
Firm-level determinants of liquidity: The case of NSE-listed Kenyan banks
(Strathmore University, 2017) Tim, Avedi Musungu
What are the key determinants of Liquidity in Kenyan Commercial banks? In the aftermath of the Global Financial Crisis as well as recent events in the Kenyan context, Liquidity and its management have been a crucial concern to industry thought leaders and policymakers. (Mwangi, 2014) and (Mugenyah, 2015) began the conversation in the Kenyan context. However, a more rigorous study is required to advance the debate and the current paper seeks to do just that. A panel data methodology is adopted with bank-fixed effects on a sample of 11 banks and 10 time periods. Two liquidity indicators serve as regressands and a set of core bank indicators as regressors. The author attempts to identify the 'best set' of core bank indicators that ultimately predict or determine liquidity in Kenyan Commercial Banks. Net Loans to Total Assets Ratio, Tier 1 Capital Ratio and Total Capital Ratio emerged as the most significant factors, highlighting the key role that bank specialization and Capital Adequacy play in the liquidity management function of listed Kenyan Commercial Banks.
Forecasting equity prices for selected companies at the Nairobi Securities Exchange
(Strathmore University, 2017) Achieng’, Sandra Ochieng’
Information asymmetry is the main cause of uncertainty in security exchanges all over the world. There are “informed investors” and “uninformed investors” with the latter having imperfect information. Due to this uncertainty, investors have been trying to come up with ways of predicting stock prices and to find the right stocks and perfect timing for when to buy or sell. The primary target of this research is to construct a model that will forecast the short term stock prices for five selected companies listed in the Nairobi Securities Exchange divided into those that are highly traded, highly capitalized and highly volatile. Secondary datasets of returns on Kenyan stock market prices were retrieved from online sources such as the Nairobi Securities Exchange website and the Valuraha platform. The model employed in this paper took the form of an autoregressive integrated moving average (ARIMA). Results obtained revealed an impressive performance of the ARIMA model in stock price prediction especially when it came to the highly traded and highly capitalized stocks.
Healthcare expenditure and economic growth: The kenyan case (1970 - 2016).
(Strathmore University, 2017) Nyamweya, Naomi Kerubo
Given that a large chunk of the National Budget is allocated to the health care sector (31.3 Billion of the 2016/7 National Budget) it is important to establish whether it is of any consequence to output. There exists a gap in finding a link between total healthcare expenditure and economic growth in Kenya. This study seeks to establish and estimate the relationship between health care expenditure and economic growth for the period 1970 to 2016. The research design used here is historical and the data used is longitudinal. Secondary data on the GDP, total health care expenditure, gross capital formation, secondary school enrollment and labor force data is collected and following Solow (1956) an economic growth model was specified. The data is analyzed using EVIEWS software. The test for multicollinearity shows that education as the efficiency factor is highly correlated with the rest of the variables hence it is dropped from the model. The Johansen cointegration test results show that the variables are not cointegrated. An OLS Model is specified. It is found that healthcare expenditure IS positively and significantly related to economic growth as measured by real GDP.
Hedging foreign exchange rate risk using currency futures: A case of Kenyan multinational firms
(Strathmore University, 2017) Mururu, Brenda Mwendwa
Currency futures contracts can be used in hedging exchange rate risk for firms. This study estimates the appropriate futures price that Kenyan multinational firms would have used during the year 2015 when the Kenya Shilling depreciated significantly relative to the US Dollar. The study also estimates the optimal hedge ratio for the two futures contracts based on simulated futures prices from historical exchange rates. The firms included in the sample are; NIC Bank, Britam, Equity Holdings, KCB Bank Group and Jubilee Holdings. The countries considered for the subsidiaries of these firms are Tanzania and Uganda. The results from the study reveal that the futures contract would have helped minimize the losses incurred by these firms during that period since the futures price at the beginning of the year is less than the spot exchange rate at the end of the year which the firms use to translate their financial statements. The hedging strategy using the futures contracts is also seen to be effective based on the R-squared values from the Ordinary Least Squares method used to obtain the optimal hedge ratios.
Impact of demographic changes on equity returns in Kenya
(Strathmore University, 2017) Thuo, Martin Mathi
Unprecedented changes in demographic structure can have significant impact on real economic activity and more so the capital market. For example; the baby boom era in the U.S, after World War II, was accompanied by a general rise aggregate demand causing an increase in aggregate supply in the economy. On the contrary, Poterba (2001) asserts that the entry of this large cohort into the labor market may have been associated with an increase in aggregate unemployment rate. While it is difficult to state with certainty the casual relationship between an increase in population and equity returns, there is evidence that shifts in demographic structure can be associated to changes in stock returns. According to Chen and Gurdip (1994) a rise in the average age tends to be followed by a rise in the market premium. They attribute this to the life cycle risk aversion hypothesis.
Impact of fiscal and monetary policy on stock market performance in Kenya
(Strathmore University, 2017) Maara, Lynette Wanjiru
Given the important role of the stock market to an economy, this study aims to explore the impact of fiscal and monetary policy on the stock market in Kenya. The study uses Structural Vector Error Correction model (VECM) while controlling for GDP and average lending rates (market interest rates). M2 is used as a proxy for monetary policy, government expenditure for fiscal policy and data on NSE-20 for stock prices in Kenya. Quarterly data spanning from 1998 to 2015 was used. Despite the results revealing that monetary policy, fiscal policy and the combined effect of the two are not significant in explaining stock price movements for the period under study, the impulse response function and error variance decomposition results suggest that the stock market variable does respond to a positive shock applied to the monetary and fiscal policy variables. However as the stock market in Kenya continues to develop, the fiscal and monetary policy variables may become significant and may have a sizeable influence on the movement of stock prices. Therefore there may be a need for coordination.
Impact of oil prices on the exchange rate in Kenya
(Strathmore University, 2017) Nyamunga, Pamella Achieng
The aim of this study is to estimate the impact of global oil prices on the exchange rate of Kenya for a monthly series from April 2000- April 2016. The modelling exercise follows 3 steps. In first step, the paper investigates the unit root test to check for stationarity in the individual variables. The second step is to run a diagnostic test to check for autocorrelation, normality and heteroscedasticity. In the third step, we estimate the equation for our model using OLS to determine its significance and the relationship between oil prices and exchange rate. The results are that oil price and exchange rate have an inverse relationship with the coefficient of oil having a negative sign. The paper goes ahead and runs GARCH test to get the conditional volatilities of exchange rate and oil price and after which a linear regression model was used estimate the relationship between the conditional volatilities of the two variables. The study then concludes that the conditional volatility between the two variables is significantly related. This implies that oil prices are a very vital variable in determining the strength of the currency and it’s volatility. The Kenyan Government should consider the impacts of oil prices when formulating and implementing economic policies, especially the exchange rate policies.
The impact of on the capital structure of listed firms in Kenya
(Strathmore University, 2017) Omondi, Veronica Sandra
The Nairobi Securities Exchange is considered one of the most developed stock markets in Sub-Saharan Africa. This development is attributed to the significant reforms that were made between the years of 1990 and 1999. The reforms include shifting from being self-regulated to having a regulatory body (Capital Markets Authority), elimination of "call-over" trading and "open outcry" trading through introduction of a Central Depository and Settlement System, tax concessions, relaxation of exchange controls and reduction of listing costs. The above reforms resulted in a development of the Nairobi Securities Exchange evidenced by the increase of the value of shares traded, market capitalization ratio and turnover ratio (Nyasha & Odhiambo, 2014).
Impact of single stock futures trading on stock market volatility
(Strathmore University, 2017) Karanja, Cindy Wangeci
This paper analyses the impact of trading single stock futures on stock market volatility. Specifically, it investigates the effect of trading single stock futures on individual stock return volatility. In addition, it aims to identify any presence of volatility feedback which is an asymmetric effect. This is based on an EGARCH model. The paper uses India stock market data on stocks from the information technology, banking, oil and gas and the consumer sectors. Eight stocks are chosen as result of ranking the stocks with single stock futures contracts based on market capitalization. First, the stocks are tested for ARCH effects which results into dropping the ITC stock. Individual EGARCH models are run followed by an extraction of the conditional volatility values. A regression is ran based on the stock returns against a dummy variable representing pre/post futures trading and the conditional volatility values. Subsequently, diagnostics tests are run for each of the EGARCH models. WIPRO displays the most conclusive results as a result of passing the model diagnostic test while the stock with the most inconclusive results was Tata Motors. Based on these results, it is evident that some of the stock returns volatility was affected by futures trading while for other stocks, there was an insignificant effect or no effect.
Industry portfolios, information diffusion and the predictability of stock returns in Kenya
(Strathmore University, 2017) Obwora, Linda Abonyo
This paper tests the hypothesis that stock return predictability exists in the Kenyan market. In particular, it investigates whether in the presence of gradual information diffusion, which is as a result of investors’ limited information processing ability, lagged industry portfolios excess returns are able to predict the NSE 20 stock market index excess returns, which serves as a proxy for the entire stock market. Five market capitalization weighted industry portfolios, namely Agriculture, Financial Services, Commercial and Services, Manufacturing and Energy and Transport are constructed using stock returns from the year 2005 to 2015. The lagged industry portfolio expected returns, the market expected returns and the industry portfolio residuals (both lagged and for the current period) are fitted into an information diffusion model and thereafter the industry predictability and information diffusion coefficients are estimated using the Arellano-Bond GMM Estimator. The findings suggest that there is no causal relationship between the industries and the stock market and no gradual information diffusion. This implies that for the Kenyan stock market, there is no stock return predictability when the analysis is performed using the industry and wider stock market approach.

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