Return volatility and the pricing of equities at the Nairobi Securities Exchange

Abstract

Using the monthly return series between 1999 and 2013 I find evidence that volatility is priced on the Nairobi Securities Exchange. The GARCH-M model yields positive and significant ARCH and GARCH parameters and the shocks of equity returns to conditional volatility are highly persistent. We find that the conditional variance is driven by the past conditional variance to a greater degree than by new disturbances. The E-GARCH model gives similar results with some marginal improvement indicating that asymmetry does not affect the relationship between risk and return. A possible explanation for these findings would be that if the future seems risky, investors may want to save more in the present thus not requiring a large risk premium. Portfolio managers may find the results of this study useful when carrying out a forward-looking valuation of a well-diversified portfolio of Kenyan stocks, as well as other similar stocks, based on market characteristics.