The Effects Of Political Risk And Macroeconomic Factors On Stock Market Performance In Kenya

ABSTRACT

This study provides a critical review of the effects of political risk and macroeconomic factors on stock market performance in Kenya. The study was undertaken due to the country’s increasingly volatile political environment following the 2007/2008 political violence that rocked the country as a result of the fiercely contested presidential elections in addition to the erratic movement in key macroeconomic variables in the Kenyan economy. Unlike previous studies that analysed the impact of political risk on stock returns in isolation, this study seeks to incorporate key macroeconomic variables such as interest rates, money supply, exchange rates, crude oil prices and inflation rate for a holistic analysis. The main objective of the study was to determine the effects of political risk and macroeconomic factors on stock market returns at Nairobi Securities Exchange, in addition the effects of each independent variable on the stock market returns at Nairobi securities exchange was determined. The study will not only be of importance to the investors seeking to invest at NSE by helping them understand how political risk and key macroeconomic variables affect the market performance but will also draw attention of the policy makers to macroeconomic factors with statistically significant effect on the stock market besides acting as a basis on which future studies will be based. The research is anchored on Arbitrage pricing theory, efficient market hypothesis and the presidential election cycle theory. Using a descriptive research design, the study examined all the companies listed at Nairobi securities exchange by employing the monthly secondary data from January 2000 to May 2013; the two leading indices, that is, NSE all share index and NSE 20 share index are used as the representatives of the returns at NSE. A multifactor regression model based on Arbitrage Pricing Theory was used to analyse the data and determine the statistical significance of the effect of each variable on market performance. Both descriptive and inferential statistics were used to analyse and present data while ordinary least square techniques are applied to test the validity of the model and the relative importance of each variables in the model using Eviews statistical package. The research findings shows that there is a high correlation between the performances of NSE all share index and NSE 20 share index; the two indices were found to be moving almost in the same direction, though reacting differently to various macroeconomic factors. The findings showed that political risk, foreign exchange rate, inflation rates and interest rates have negative effect on the performance of NSE all share index. In regards to the performance of NSE 20 share index political risk, foreign exchange rates and interest rates had negative effect. On the contrary Oil prices and money supply were found to have positive relationship with both indices. Political risk had a statistically significant effect on the NSE performance. Based on the results, the researcher recommends that investors at NSE pay attention to both political risk, international oil prices, inflation and foreign exchange rates due to the significant effect these variables have on the market performance while the government and policy makers should ensure stability in political and macroeconomic environment as this is important for the overall performance of the stock market in Kenya.