The relationship between macroeconomic variables and stock returns in the Nairobi Securities Exchange
A clear understanding of the movements and sensitivity of each macroeconomic variable with respect to behavior of the stock returns is of importance to the general economy as it facilitates its growth and enables investors to avoid risks and to be able to generate satisfactory returns from investment in financial assets in securities market. This study examined the relationship between stock returns and five macroeconomic variables namely, treasury bill rate (lnir),money supply(lnms),inflation rate(lninf),foreign exchange rate(lnforex) and gross domestic product(lngdp) using Johansen’s cointegration test, Granger causality test and the VECM framework. The analysis employed monthly data for the period of January 2004 to December 2013 which were obtained from the central bank of Kenya, Nairobi securities exchange and the Kenya national bureau of statistics. The Johansen’s cointegration test suggests that the stock returns have either a positive or a negative relationship with the macroeconomic variables. Stock returns were found to be positively related to foreign exchange, money supply, GDP and inflation while it was found to be negatively related to interest rates. The coefficient of the co-integrating equation for stock returns shows that 3.6 percent of deviation or departure from the equilibrium path is recovering each month (as monthly data has been used in the study). So the error correction figure is good, significant and steady one in approaching towards long run equilibrium which will take 20 months for stock returns to return to equilibrium. The findings from the Granger causality test based on the VECM indicate that there exists a bi-directional causality between money supply and inflation rates. This finding suggests that future share returns can be estimated using interest rates and the GDP for the Kenyan case. The results also show that NSE 20 Share index does not Granger causes any macroeconomic variable in Kenya within the sample period.