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MACROECONOMIC VARIABLES AND STOCK MARKET RETURNS VOLATILITY IN NIGERIA
ABSTRACT
GARCH (1, 1) and the E- GARCH (p, q) techniques were used in this study to evaluate the volatility clustering in the stock market returns. Interest rates, inflation rates and exchange rates were themacroeconomic determinantfactors to stock market returns volatility in Nigeria, covering the period, 1995 to 2014. The study revealed that inflation, interest rates and exchange rates were volatile and move in clusters, with the following valuesof GARCH coefficient β 0.966349, 0.9662 and 0.764638 respectively, with p-values significant at 1% level. The research also showed that interest rate has a negative relationship with stock market returns, with a correlation coefficient of –0.5531,while inflation and exchange rates have a positive relationship with stock market returns, with correlation coefficients of 0.6872 and 0.6161 respectively. There is high and persistent volatility in the stock
market returns, based on the values of the α 0.460889 and β
0.682731coefficients.Interest rates, inflation rates and exchange rate exerted significant impact on the stock market returns volatility in Nigeria, at 1% level of significance. Models developed in this study should be employed by the regulatory authorities to make polices that will minimize volatility, by keeping interest rates low thereby stabilizing exchange rate and managing inflation within the single digit range, to minimize stock market returns volatility in Nigeria.
Keywords: Macroeconomic Variables, Stock Market Returns, Volatility Clustering, Monthly Series.
TABLE OF CONTENTS
Title page i
Certification ii
Dedication iii Acknowledgements iv
Table of Content v
List of Tables x
List of Figures xii
Abstract xiii
Chapter One Introduction
1.1 Background Information 1
1.2 Problem Statement 6
1.3 Objectives of the Study 9
1.4 Hypotheses of the Study 9
| 1.5 Justification of Study | 10 |
| 1.6 Scope of Study | 10 |
| Chapter Two Literature Review
|
12 |
| 2.1Conceptual Frame Work | 12 |
| 2.1.1 Risk Diversification: Systematic and Unsystematic Risk | 14 |
| 2.1.2 Stock Market Volatility and Real GDP | 15 |
| 2.2 Theoretical Framework | 18 |
| 2.2.1 The Efficient Market Hypothesis | 18 |
| 2.2.2 Capital Assets Pricing Model (CAPM) | 22 |
| 2.3Review of Related Empirical Studies | 22 |
| 2.3.1 Volatility of stock Market and Returns | 23 |
| 2.3.2 Stock market and Macroeconomic Variables | 31 |
2.3.3 The Causal Relationship between Stock Market and Macroeconomic
Variables 45
- 4Stock Market Volatility 52
2.3.5 Time-Varying Volatility Modeling: The Conditional
Variance Exposition 61
2.3.6 Stock Market Volatility and Information Asymmetry 65
2.3.7 Arguments on the Nature of Stock Market Volatility Over Time 70
2.3.8 Volatility of Stock Returns and Nigerian Stock Market 75
2.4 Evaluation of the Literature Reviewed 76
- Research Gap 80
- Summary of Result 81
Chapter Three Methodology 83
- Research Design 83
-
Models and variables 84
- Theoretical Framework of Volatility Models 85
- The Autoregressive Conditional Heteroscedasticity (Arch) Model 85
- The Generalized Autoregressive Conditional Heteroskedasticity
(Garch) Model
- The Exponential Garch (Egarch) Model 90
- The Threshold Garch (Tgarch) Model 91
- ARCH-X, GARCH – X Models 92
-
7Model Result Testing 93
- Population and Sample 94
- Data and Data sources 95
-
Techniques of Data Analysis 95
- Analytical Framework 97
- Justification of Economic Model Used 99
- Model Specification 99
- Statistical Software used 103
- Apriori Expectation 103
- Limitations of the method 104
Chapter Four Results and Discussion 106
4.1 Results 106
4.1.1 Summary Statistics of Data 107
4.2 Analysis of Research Data 108
4.2.2 Data Analysis 111
4.3Tests of Hypothesis 116
- Interpretation of Result and Findings 117
- Discussion of Findings 127
Chapter Five Conclusion and Recommendations 129
5.1 Conclusion 129
5.2Recommendations 131
5.3Contribution to Knowledge 133
References 135
Appendix 153
CHAPTER ONE
1.0 INTRODUCTION
1.1 Background Information
In the financial sector the stock market serve as the engine of growth, that efficiently allocate resources to entities seeking expansion, as a complex institution infused with inherent mechanism through which long term funds of the major economic sectors such as households, governments and firms are mobilized, allocated and channeled to various sectors. It is of concern to the government, investors as well as other stake holders. Macroeconomic Variables has been known to influence stock market return volatility globally, high volatility in the stock market return causes crashes and crisis in the financial sector, which has negative economic consequences. However the magnitude to which these variables affect the stock market returns, to the extent of being critical causal factors of stock market return volatility is the main focus of this study. This study focused on three macroeconomic variables, (interest rates, inflation rates and exchange rates) due to how swift changes in these variable affect stock market return volatility.(Olweny&Omodi, 2011), the stock market plays an important role in financial intermediation in both developed and developing nations (Lawal&Okunola, 2012; Govati, 2009). This means that, the stock market helps in mobilizing funds from surplus savings unit to deficit unit in the economy and ensures that savings of surplus units are mobilized and efficiently allocated, so that it can assist in enhancing capacity utilization as well as promoting productive activities and consequently leading to economic growth and development in the economy. (Lawal&Okunola,2012; Alajekwu &Achugbu, 2012). The stock market and banking system play an important role to achieve macroeconomic objectives of a nation. Thus, the overall economic development of a nationdepends on how well the stock market performs(Lawal&Okunola, 2012).
However, an important issue in the stock market which deserves special consideration is the issue of high volatility, the existence of which may undermine the ability of the stock market to promote an efficient fund allocation for investments (Arestis, et al., 2001).
Volatility refers to sharp fluctuation in the price of a financial asset or market in a short period of time. ―Stock volatility can be defined as the possibility that a given stock will experience a drastic rise or fall in value within a time period‖ (Okpara, 2011). The main problem of stock price fluctuations affecting stock market efficiency is the destructive impact of excess volatility which causes market crashes and crisis (Goudarzi&Ramanarayanan,2011).
Furthermore, stock market volatility is an undiversifiable risk (i.e systematic risk) faced by investors holding a market portfolio for example stock market index fund (Guo, 2002;Rano, 2010) states, that excess volatility breads uncertainty, which hampers effective performance of the financial sector as well as the entire economy at large. According to Bhawmik (2013) a very high stock market volatility induces instability in capital market, destabilizes the value of currency and hampers international trade and finance. Some researchers also contend that rising stock market volatility might decrease future economic activities (GUO, 2002). Suleiman (2011) also stated that stock market volatility affects business investment and economic growth. Petros (2011)stated, that the higher the stock market volatility in less developed countries, the lower the efficiency of the price signals in allocating investment resources.
Stock market volatility affects the trading behavior of investors. Investors evaluate the volatility ofshares already in their portfolio before selling stock currently in their possession.
Higher volatility in stock prices has adverse effect on the economy. It influences investors to make changes in their investment decision, which may lead to a fall in the long term capital flow from foreign and domestic investors, as experienced in the Nigerian capital market during the global economic meltdown in 2008. The Nigeria capital market is yet to recover from this. The stock market volatility has large impact on the economic condition of a country, policy makers, financial managers, firms, inventors as well as other stakeholders
(Mustag et al., 2011).
Thus a clear understanding of stock market volatility will enable stakeholders predicts the market and averts potential losses.
Against the above background, this study investigated the impact of macroeconomic variables (interest rate, inflation rate and exchange rate) on stock market returns volatility in Nigeria from 1995 to 2014. The selection of interest rate, inflation rate and exchange rate, as macroeconomic variables of focus is based on the spontaneous response their volatility generate in the stock market returns.
The history of the Nigerian stock exchange (NSE) dates back to 15th of September, 1960, when the Lagos stock exchange was established, which began its operation on 5th June, 1961 with 19 securities listed on its floor for trading.
In December 1977, it was renamed as the Nigerian Stock Exchange (NSE).
The exchange currently has about 258 listed securities, which comprise equities, corporate bond/debentures, federal government bonds, state and municipal bond, exchange traded fund and supranational bond, and also has about 200 listed companies in twelve diverse sectors, including several global brands (NSE- FAQs; NSE-Gateway to African Markets; NSE-Q3 2013 Fact Sheet). The NSE has two Equities markets: First tier securities market (the Main
Board) and Second tier securities market [Alternative Securities Market Board (ASeM)] . The second tier securities market (i.e. ASeM) was established by exchange in 1985 in order to help the Nigerian small and medium companies with high potential of growth to raise long-term capital at relatively low cost from the market (NSE-FAQs;). The difference between the two has been falling, which also lead to decline in the ASI as well, (although there were some positive changes in the index in February, April and March of 2009).
Time Series Plot of Nigeria Stock Market Returns
January 1995 to December 2014
Fig1.1 Time Series Plot Of Nigeria Market Returns Jan. 1995 – Dec. 2014
Many investors realize that the stock market is a volatile place to invest their money. The daily, quarterly and annual movements can be dramatic, but it is this volatility that also generates the market returns investors experience. In this studywe explained how volatility affects investors returns and how to take advantage of it.Volatility is a measure of dispersion around the mean or average return of a security. One way to measure volatility is by using the standard deviation, which tells how tightly the price of a stock is grouped around the mean or moving average (MA). When the prices are tightly bunched together, the standard deviation is small. When the pricemovements are spread apart, a relatively large standard deviation occurs.
In the context of this study the impact of inflation, exchange rate and interest rates on stock market returns is measured to determine their impact and magnitude. From Fig.1.1 the graph shows that the spikes were highest between 2008 and 2009 representing the period of the global melt down. The stock market return was volatile between 1995 and 2014. Thus the need to find out the impact of inflation, interest rates and exchange rate on stock market returns volatility in the Nigerian Stock Market.
1.2 Problem Statement
The role of the stock market in ensuring that the funds from surplus unit are mobilized and efficiently allocated to various sectors of the economy is important; the stock market serves as the engine of economic growth and development in both developed and developing economies.
The existenceof high stock market returns volatility in such market may hinder the stock market from playing such a role properly. Volatility may affect the effective functioning of stock market and negatively affect economic performance.
The existence of excessive volatility may lead to an inefficient allocation of resource, increases interest rate,exchange rate and inflation in view of higher uncertainty, hampering both quantity and productivity of investment and consequently reducing growth.
High stock market volatility affects investors‘ confidence, thus the probability of both domestic and foreign investors to invest in such market will be minimized.
This is because the returns on such market are liable to higher risk and this may affect the economic growth of that country.
The level of volatility in the stock market could be used as an index in assessing the state of the economy.
The effect of the recent global financial crisis in the Nigerian stock market, caused mainly by the industrialized economies, negatively affectedNigerian stock market , which caused a significant decrease in economic activities and resulted in losses amongst investors and other stake holders (domestic and foreign investors, institutional investors, financial institutions and firms), the implication is that the stock market volatility is one of the most important factors in the economic growth of both developed and under developed countries like Nigeria
Economic activities and output are adversely affected by high stock market returns volatility. From fig.1.1 the Nigerian stock market shows evidence of high and persistent volatility.Very high stock market volatility induces instability in the capital market, destabilizes the value of domestic currency and hampers international trade and finance.
Stock market volatility occurs mostly in under developed countries, which causes a dysfunctional price signal in allocating investment resources, thus influencing trading behavior of investors. Investors evaluate the volatility of the stock already in their portfolio before trading the stock currently in their possession.
Higher volatility in stock prices has adverse effect in the economy. It influences investors to make changes in their investment decision which may lead to fall in long term capital flow from foreign and domestic investors, as experienced in Nigeria capital market during the global economic meltdown in 2008 which Nigeria capital market is yet to recover.
This study investigated the extent to which empirical evidence exist to suggest that volatility in inflation, interest rates and exchange rates are critical causal factors of stock market return volatility in Nigeria. The high volatility in the Nigeria stock market has various consequences which include:
- Loss of investor confidence.
- Destabilizes value of currency.
- Reduction in business and economic activities.
- Hinder the stock market from playing it role in economic development.
It is therefore against this back ground of the adverse effects of the stock market volatility that necessitatedthe need for this study.
1.3 Objectives Of Study
The main objective of this study is to analyze the impact of macroeconomic variables on stock market return volatility in Nigeria, the specific objectives are:
- To examine whether there is volatility clustering in the Nigerian stock market returns.
- To evaluate the effect of interest rate volatility on stock market return volatility clustering in Nigeria.
- To determine whether inflation rate volatility significantly impact stock return volatility in Nigeria.
- To evaluate the effect of exchange rate volatility on stock return volatility.
1.4 Hypotheses Of The Study
Based on the above objectives, the following hypotheses are formulated for the study:
HO1: There is no volatility clustering in the Nigeria stock market returns.
HO2: Interest rate volatility does not significantly impact on stock market returns volatility in Nigeria,
HO3: Inflation rate volatility does not significantly impact on stock market returns volatility in Nigeria.
HO4:Exchange rate volatility has no significant impact on stock market return Volatility.
1.5Justification of Study
The issue of uncertainty which sometimes causes volatility and results into losses in the stock market value is a source of concern to regulatory authorities, portfolio managers, brokers and other stakeholders.
The outcome of this study will enable major stakeholders to have an empirical evaluation of the stock market return volatility and the impact of interest rates, Inflation rates and exchange rate on stock market returns volatility. With a clear understanding, stakeholders will have a tool for predicting the stock market return volatility, which will enable the regulatory authorities take measures to minimize volatility, and thus improve Nigeria‘s economic performance. Portfolio managers, investors and stock brokers will be able to adopt the right diversification strategy to hedge against the risk of increased projected future stock market volatility.
The results obtained from this study will arm regulatory authorities, portfolio managers, multinational companies, stock brokers and other stakeholder to make informed investment decisions.
1.6 Scope Of Study
The data used was collected from the Nigeria Stock Exchange (NSE),CBN
Economic and Financial Reviews. This research work covers the activities of thestock market from 1995 to 2014. The study investigated the impact of macroeconomic variables on stock return volatility in Nigeria, using the All Share Index (ASI) as proxy with specific focus on the impact of exchange
rate,interest rates and inflation rates on stock return volatility.
The researcher is focusing on the three explanatory variables (interest rates, inflation rates and exchange rates), amongst other macroeconomic variables that impact on stock market return volatility in Nigeria.
MACROECONOMIC VARIABLES AND STOCK MARKET RETURNS VOLATILITY IN NIGERIA
