Factors influencing bond market liquidity in Kenya

Abstract

This study aimed to determine the factors influencing bond market liquidity in Kenya using the Vector Error Correction Model. This paper investigates the factors influencing bond market liquidity in Kenya from 2010 to 2021. We employ a combined approach utilizing Vector Error Correction (VEC) on monthly data. The VECM framework allows us to capture the dynamic interrelationships between various factors and bond liquidity. It is especially suitable for use on cointegrated multivariate time series data. Our research explores the influence macroeconomic factors. Macroeconomic factors encompass variables like bank lending interest rates and foreign exchange rates. By utilizing this comprehensive approach, the study aims to provide a more nuanced understanding of how various elements contribute to Kenya's bond market liquidity. The findings can be valuable for policymakers, market participants, and researchers seeking to enhance the efficiency and stability of the Kenyan bond market. The findings suggest that previous bond market turnover, interest rates and stock market index are strong significant predictors of current bond market turnover. The foreign exchange rate is also a significant indicator of current bond market turnover. However, the other economic indicators, Inflation (CPI) and Repo rate show no predictive power in this model. The model explains a moderate portion of the variability in bond turnover, and the overall model is statistically significant. These results can inform financial analysts and policymakers about the key factors influencing bond turnover and guide further investigation into other potential predictors.