The Effect of interest rates and inflation on stock market returns: a case study of the Nairobi Securities Exchange

Abstract

Stock market provides a platform for enhancing savings and investment which encourages investors with surplus funds to invest in various financial instruments in accordance with the level of risk, liquidity and other key financial factors that might affect their investment. This study focuses on the Kenya’s economic environment and on two major macroeconomic variables which include interest rate and inflation. This study aims to achieve three primary objectives: to analyze the impact of inflation on stock market returns, to examine the effect of interest rates, and to assess their combined influence on the performance of NSE-listed firms. Using a quantitative research design, the study utilizes historical data on inflation rates, interest rates, and stock market returns over a specified period. Financial Econometric models, including regression analysis, are employed to determine the relationships and assess the magnitude of these effects. Preliminary findings suggest that inflation and interest rates significantly affect stock market returns, although their impacts vary across different sectors and time periods. Using secondary data from the CBK and NSE, this descriptive time series correlation analysis model’s monthly inflation rates and least squares regression analysis of order is estimated to establish the link held betwixt monthly market gains and a host of other critical economic components. In the model, monthly market returns serve as an outcome variable. These returns will be influenced by the monthly rates of inflation, the monthly interest rates, the spot exchange rates at the end of each month, and the liquidity in the market at month's end, all acting as predictor variables. We try to see how these indicators of the economy come together to influence the performance of the market every month using OLS.