THE EFFECTS OF INFLATION ON THE PERFORMANCE OF THE NAIROBI

SECURITIES EXCHANGE, KENYA

BY

NAME

ADMISSION NUMBER

1.

MAINA MILLICENT WANJIRU

BA/00053/011

2.

NGANYI JONES INGARI

BA/00057/011

3.

KIGAMBA LUCY NYATHIKA

BA/00059/011

4.

JEMUTAI DEBORAH

BA/00060/011

5.

MOSE BEATRICE

BA/00061/011

6.

MWANGI M. MARY

BA/00062/011

7.

NYAMANYA SYDDRINE GETUGI

BA/00076/011

8.

MUNGAI GICHUHI JOHN

BA/00077/011

9.

MWAURA MARTIN MUTURI

BA/00085/011

10.

NJERI EPHANTUS GACHOKA

BA/00086/011

11.

KOSEN NTERERE DAVID

BA/00098/011

12.

NGANGA GEORGE WAWERU

BA/00102/011

13.

MBALI JUDITH MUENDO

BA/00104/011

A Research project submitted in partial fulfillment of the requirements for the award of a
Bachelor of Arts in Economics with Information Technology degree of Maseno University.
APRIL 2015

DECLARATION

We declare that the research proposal and the subsequent project have been done by the
following students;
ADMISSION NUMBER

NAME
1. MAINA MILLICENT WANJIRU

BA/00053/011

2. NGANYI JONES INGARI

BA/00057/011

3. KIGAMBA LUCY NYATHIKA

BA/00059/011

4. JEMUTAI DEBORAH

BA/00060/011

5. MOSE BEATRICE

BA/00061/011

6. MWANGI M.MARY

BA/00062/011

7. NYAMANYA SYDDRINE GETUGI

BA/00076/011

8. MUNGAI GICHUHI JOHN

BA/00077/011

9. MWAURA MARTIN MUTURI

BA/00085/011

10. NJERI EPHANTUS GATHOKA

BA/00086/011

11. KOSEN DAVID NTERERE

BA/00098/011

12. NGANGA GEORGE WAWERU

BA/00102/011

13. MBALI JUDITH MUENDO

BA/00104/011

SIGNATURE

DECLARATION BY THE SUPERVISOR

This research project has been submitted for examination with the approval as the university
project supervisor.
2

Sign

Date

Dr. Destaings Nyongesa,

School of Business and Economics,
Department of Economics,
Maseno University
ACKNOWLEDGEMENT
We give thanks to God Almighty for giving us the strength, knowledge and health to carry out
this study as requisite of completing our Bachelors degree in Economics with Information
Technology.
The project that we have undertaken would not be complete without the support and unwavering
dedication of our esteemed lecturers for making us comprehend vital economic course units
which have been of great importance in this research project.
We also like to thank our supervisor Dr. Destaings Nyongesa for his guidance and support during
the study.

DEDICATION
This study is dedicated to our loving families and friends who tirelessly motivated and supported
our efforts throughout the duration of the study and the entire degree course.

ABSTRACT
Inflation refers to the sustained increase in the general price level of goods and services in an
economy over a period of time. Inflation reflects a reduction in the purchasing power per unit of
money-a loss of real value in the medium of exchange. This reduction in the purchasing power of
money has effects in both the demand and supply of commodities in all markets including
securities exchanges. This research aims to determine the effects of inflation on the performance
of the Nairobi Securities Exchange by focusing on the effects of inflation on the various
magnitudes used to quantify the Nairobi Securities Exchange performance; market capitalization,
equity turnover and the NSE 20 share index. Secondary inflationary data was collected from the
Kenya National Bureau of Statistics while the other data variables were collected from the
Capital Markets Authority annual reports. Acquired research data was analyzed using Minitab
version 17. The aim was to establish a predictor model having the market capitalization, equity
turnover and NSE 20 share index as the dependent variables and inflation as the independent
variable. Scatter diagram, descriptive statistics and simple regression models were used in the
analysis. The study recommends stringent control of the inflation rate to make it more
predictable and create a favorable investment environment. The study further recommends
investigation of the other factors affecting the performance of the Nairobi Securities Exchange
other than inflation.

ABBREVIATIONS
CMA

Capital Markets Authority

CPI

Consumer Price Index

FED

Federal Reserve Bank

GARCH

Generalized Autoregressive Conditional Heteroskedasticity

KNBS

Kenya National Bureau of Statistics

NSE

Nairobi Securities Exchange

Mc

Market Capitalization

Mt

Equity Share Turnover

N20

Nairobi Stock Exchange 20 Share Index

VAR

MENA

Vector Autoregressive models

-

Middle East and North Africa region

DEFINITION OF TERMS
Inflation refers to a sustained increase in the general price levels of goods and services in an
economy over a period of time.
Market Capitalization is the total market value in shillings of shares outstanding over all
publicly traded companies. It is equivalent of the product of share prices and number of shares
outstanding.
NSE 20 share index is a price weight index that measures the performance of 20 blue-chip
companies with strong fundamentals and which have consistently returned positive financial
results. Members are selected based on weighted market performance for a 12 month period as
follows; Market capitalization 40%, Shares traded 30%, Number of deals 20% and Turnover
10%.
Equity share turnover measures the liquidity of companies stocks.

Table of Contents
7

CHAPTER ONE............................................................................................................................10
INTRODUCTION.........................................................................................................................10
1.1

Background of the study.................................................................................................10

1.2

Statement of the Problem................................................................................................13

1.3

Research Objectives........................................................................................................14

1.4

Research Hypothesis.......................................................................................................15

1.5

Scope of the study...........................................................................................................15

1.6

Justification of the study.................................................................................................15

1.7

Theoretical framework....................................................................................................16

CHAPTER TWO...........................................................................................................................18
LITERATURE REVIEW...............................................................................................................18
2.1

Introduction.....................................................................................................................18

2.2

Theoretical Literature......................................................................................................18

2.3

Empirical literature.........................................................................................................20

2.4

Literature on inflation and NSE in Kenya......................................................................30

2.5

Summary of the gaps to be filled....................................................................................32

CHAPTER THREE.......................................................................................................................33
RESEARCH METHODOLOGY..................................................................................................33
3.1

Introduction.....................................................................................................................33

3.2

Research Design..............................................................................................................33

3.3

Population.......................................................................................................................33

3.4

Sample Design& Sample Size........................................................................................34

3.5

Data Collection...............................................................................................................34

3.6

Data Analysis & Presentation.........................................................................................34

CHAPTER FOUR.........................................................................................................................36
RESULTS AND DISCUSSIONS..................................................................................................36
4.1

Introduction.....................................................................................................................36

4.2

Descriptive Statistics.......................................................................................................36

4.3

Correlation Analysis........................................................................................................41

4.4

Regression Analysis........................................................................................................43

4.4.1

Effects of Inflation On NSE 20-Share Index...........................................................43

8

4.4.2

Effects of Inflation on Equity Share Turnover.........................................................44

4.4.3

Effects of Inflation on Market Capitalization..........................................................45

4.5

General Discussion.........................................................................................................46

CHAPTER FIVE...........................................................................................................................47
SUMMARY, CONCLUSION & RECOMMENDATION.............................................................47
5.1

Introduction.....................................................................................................................47

5.2

Summary of the findings.................................................................................................47

5.3

Conclusion......................................................................................................................48

5.4

Recommendations...........................................................................................................48

5.5

Areas for further research...............................................................................................49

REFERENCES..............................................................................................................................50
APPENDIX I.................................................................................................................................52
APPENDIX II................................................................................................................................52

List of Table
Table 4.1 Descriptive Statistics Data table....................................................................................36
Table 4.2 Pearson Correlation Analysis Data Table.......................................................................41
Table 4.3 Regression Analysis Data Table.....................................................................................43

List of Figures
Figure 4.1 Inflation Rate Time Series Plot.....................................................................................38
Figure 4.2 NSE 20-Share Index Time Series Plot..........................................................................39
Figure 4.3 Equity Share Turnover Time series Plot.......................................................................39
Figure 4.4 Market Capitalization Time Series Plot...40

CHAPTER ONE

INTRODUCTION
1.1

Background of the study

Inflation has always been a contentious issue to any country in the world, most especially the
regimes that citizens have chosen head their respective governments and represents their
collective interests. The effects of inflation on the economy are diverse and can be both positive
and negative. The negative effects are however most pronounced and comprise a decrease in the
real value of money as well as other monetary variables over time. As a result, uncertainty over
future inflation rates may discourage investment and savings, and if inflation levels rise quickly,
there may be shortages of goods as consumers begin to hoard out of anxiety that prices may
increase in the future.
According to Geetha et al. (2011), financial theorists believe that there are direct and indirect
aftermaths of inflation in every sector of the economy ranging from exchange rates, investment,
unemployment, interest rates, and stock markets among others. These researchers concluded that
inflation and stock markets share a very close association, and that the rate of inflation influences
stock market volatility. Kenya as one of the developing countries has not been spared from these
inflationary effects. Moreover, it has been hard hit by these effects of inflation which have led to
increase in the cost of living beyond the reach of most of her citizens who live below the
purchasing power parity of a dollar. These negative inflationary effects also have hit the stock
market hard leaving both domestic and international investors with huge losses. Inflation in
Kenya has been unstable and fluctuating. Increased inflation is associated with high cost of
living thereby reducing amount savings available for investment. The government aims to
maintain a constant rate of inflation characterized by a single digit. The aim has been to make
10

inflation almost predictable and not sporadic as it has been in the Kenyan economy. Consumer
Price Index (CPI) is used in measurement of inflation in Kenya.
The Kenyan economy in the last three decades has experienced both extremes of high and low
inflation with highest ever recorded inflation rate being in September of 1993 of 56.2% and an
annual high of 46% in the same year. It has also fallen to an all-time annual low of 1.6% in 1995,
(annual inflation data from KNBS). The high inflation rate may have been attributed to rising
food prices, inefficient and poor transport services, port congestion, depreciation of Kenyan
Shilling against major currencies like the dollar, massive rent-seeking by powerful individuals in
the government of the day and rush to spend budgetary allocations by government ministries.
On the other hand, stock markets promote savings and investments by providing an avenue for
portfolio diversification to both individual and corporate investors. These markets fuel economic
growth through diversification, mobilizing and pooling of savings from different parties and
availing them to companies for optimal utilization. The equity markets create a forum for trading
in financial assets, whereby business firms are able to acquire investment funds through the
issuance of shares; and thus facilitating them to meet their investment objectives. Stock markets,
as Olweny and Kimani (2011) observed, encourage investors with surplus funds to invest them in
additional financial instruments that better matches their liquidity preferences and risk appetite.
In that respect, better savings mobilization increases the savings rate, thereby stimulating
investments and subsequently earning investment income to the owners of those funds. In
addition, the liquid nature of these markets makes it possible for the investors to exchange
ownership of securities, and reap capital gains in the process.

11

The bourses performance has experienced various tidal occurrences signified by one of its
performance measures, the NSE 20-share index. It recorded sharp drop to 3531 points by end of
Dec 2008 (KNBS, 2009). The NSE 20 Share Index fell by 7.8% to stand at 3,247 points in
December 2009 compared to 3,531 points December 2008 (KNBS, 2010). The Nairobi Stock
Exchange (NSE) 20 share index rose steadily over the first three quarters of 2010 to reach a peak
of 4,630 points during the third quarter. The index edged downwards slightly in the fourth
quarter but remained relatively high at 4,433 points at the end of December 2010 compared to
3,247 points in December 2009 (KNBS, 2011). Since February 2009 there has been an increase
in net foreign equity outflow at the NSE with the highest figure of Kshs 1 billion recorded in
September 2009. Total for the year to date is Kshs 4 billion showing increased confidence by
foreign investors (CMA, 2009). Foreign investor participation at the NSE as measured by
average turnover figures dropped by 9%, from an average of 52% in the first quarter, 2010 to an
average of 43% in the second quarter, 2010. In the first quarter, 2010, the NSE realized a Kshs. 5
billion net foreign investor cash inflow. The second quarter, 2010, saw that foreign investor
inflow contract by Kshs. 3.6 billion to Kshs. 1.4 billion. However, in June 2010 the inflows
picked up (CMA, 2010). NSE has 56 listed companies, Agriculture 4, Commercial and Services
11, Finance and Investment 16, Industrial and Allied 17 and Alternative Investment Market 8.
In an attempt to find reprieve from the economic shocks experienced by the entire economy and
its citizens, the Central Bank of Kenya has undertaken stringent measures in its regulatory
capacity to see to it that inflation rates do not surpass double digit threshold and that citizens are
cushioned against escalating costs of living. These measures vary from one time to the next but
are all aimed at ensuring the economic soundness of the monetary system and economy. Among
the most popular and accepted strategies are the exchange rate targeting, money supply and
12

demand targeting, NSE targeting, nominal GDP targeting and inflation targeting. It does so
through monetary and fiscal policies. Inflation targeting is the process of offering a framework of
constrained discretion in which the constraint is the inflation target and the discretion is the scope
and flexibility of taking into account of the economic and other considerations (Kuttner& Posen
2000). Inflation targeting is also defined as that form which disregards entirely the real effect of
monetary both in the short and medium term and focuses on controlling inflation within the
shortest possible time horizon (Svensson 2001).Hence rapid output growth and low inflation are
the most common objectives of macroeconomic policy. Inflation may reduce a countrys
international competiveness by making exports relatively more expensive thus impacting
negatively on the balance of payment, capital market performance, in addition to reducing capital
accumulation and productivity growth. Due to these and much more effects of inflation, the main
aim of this research is to empirically analyze the effects of inflation on the Nairobi Stock
Exchange performance in the Kenya.

1.2

Statement of the Problem

Studies conducted globally on the relation between inflation and Stock market performance have
given divergent results on the issue. Feldstein (1980) in the paper on Inflation and the Stock
Market observed that stock prices boost when inflation is at high constant rate while they fall
when expected inflation rate rises. However, Fama and Schwert (1977) gave an idea of negative
relationship between stock returns and Inflation (both expected and unexpected). On the other
hand Modigliani and Cohn (1979) in the Inflation Illusion Hypothesis claim that stock market
investors fail to understand the effect of inflation on nominal dividend growth rates and
extrapolate historical nominal growth rates even in periods of changing inflation. This implies

13

that stock prices are undervalued when inflation is high and may become overvalued when
inflation falls.
In Kenya, Ngugi (2008) observed that the performance of stock market is influenced by a
number of factors the main ones being government policies, general performance of the economy
and inflation. Siele (2009) in the Study on the relationship between stock market and selected
macroeconomic indicators observed that market share index is positively related to inflation rate,
Treasury bill rate and gross domestic product. Kaimba (2010) also observed significant
relationship between the NSE 20 share index and selected macro-economic variables. Kiptoo
(2010) observed significant relationship between the NSE 20 share index and both exchange rate
and inflation.
The dilemma created by the various theories advanced to explain the relationship between
inflation and share prices and the divergent results obtained from the empirical data on global
studies creates the need to have a specific study for Kenya. We would like to point your attention
to the fact that previous studies have concentrated on the effects of inflation on facets of the
stock market which determine its performance and not entirely on the general performance. It is
against this background that the study decided to investigate the effects of inflation on the
performance of the Nairobi Securities Exchange.
1.3

Research Objectives

The main objective of the study is to assess the effect of inflation on the NSE performance. The
specific objectives of this study are;
i.
ii.
iii.

To assess the effects of inflation on market capitalization.

To determine the effects of inflation on the stock market turnover.
To analyze the effects of inflation on the NSE 20 share index.
14

1.4

Research Hypothesis

HO: Mc = 0: Inflation has no effect on market capitalization (Mc)

HA: Mc 0: Inflation affects the market capitalization
HO: Mt = 0: Inflation has no effect on stock market turnover (Mt)
HA: Mt 0: Inflation affects stock market turnover
HO: N20 = 0: Inflation has no effect on the NSE 20 share index (N20)
HA: N20 0: Inflation affects the NSE 20 share index
1.5

Scope of the study

The study was based on the analysis of market capitalization data, equity share turnover and
share indices of the 20 best performing listed companies

trading at the Nairobi Securities

Exchange, taking the annual data between years 1990 and 2014. It also based its studies on
inflation data, collected during the same period from the Kenya National Bureau of Statistics.
1.6

Justification of the study

The linkage between inflation and NSE market performance if any has not drawn the interest and
attention it deserves from researchers. Researchers have however done a lot on the linkage
between inflation and capital markets and linkage between inflation and capital stock returns.
The linkage of inflation on either capital markets and stock returns have a strong linkage on this
study as market capitalization also constitute in the calculation of the performance of the NSE
market. This study will offer a basis for further improvement of the various theories advanced to
explain the relationship between inflation and NSE market performance and establish the
relevance to the Kenyan economy. The study will also be helpful to policy makers in setting up
appropriate standards on NSE that will lead to favorable trading prices to the final consumers
15

and investors. It will also help academicians as they will get the required knowledge for future
analysis and policymaking. The study will be beneficial to investors in making timely decisions
by speculating on the right instances to commit their assets to the NSE market. The Government
will benefit from the study by formulating appropriate policies in regard to inflation and
promotion of investment in NSE market.
1.7

Theoretical framework

The theoretical framework behind this research is based on the Monetary Theory of inflation.
Monetarists argue that if the money supply rises faster than the rate of growth of national income
then there will be inflation; however, if money supply increases in line with the inflation rate,
then there will be no inflation. Classical economists such as Milton Friedman and Fisher tried to
explain the monetary phenomenon. Using the Quantity theory of money, Fisher tried to explain
how money supply and demand comes into play. Fisher equated the equation;
MV=PT
Where: M=Money Supply
V= Velocity of Circulation
P=Price Level
T=Transactions
The level of transactions (T) is usually hard to measure, so it is usually equated to Y, the national
income of a country.
Therefore V=PY

16

Where Y = National Output.

The above equation must hold the value of expenditure on goods and services, which must equal
the value of output. However, they argue it is the unwarranted increase in the money supply that
causes inflation. Monetarists believed that in the short term, Velocity (V) is fixed because the rate
at which money circulates is determined by institutional factors. For example, the number of
times workers are paid is mainly held constant over a time period say once a month, and the
amount paid and duration does not change often. Friedman insisted that the fact that V changes
slightly, it can be treated as fixed as compared to treating it as a variable input. Output is also
fixed in the long run, though it may change in the short run. Therefore, an increase in money
supply will lead to an increase in inflation because of these fixed factors. This study also aims to
look at whether the increase in money supply that causes inflation also impacts stocks trading in
the NSE, affecting the magnitudes of market capitalization, equity stock turnover and the NSE
20-Share Index.

17

CHAPTER TWO

LITERATURE REVIEW
2.1 Introduction
This chapter contains scholarly articles on theoretical literature and empirical literature on the
effects of inflation on market capitalization, market indices and equity share turnover. It also
contains literature for NSE and inflation.

2.2 Theoretical Literature

The linkage between stock market performance and macroeconomic variables has attracted a
great deal of research interest in the past, with the growing literature revealing strong influence
of inflation on stock market indices particularly for industrialized countries (Hondroyianns and
Papapetrou (2001); Lovatt and Ashok (2000); Nasseh and Strouss (2000). In a past survey, Cohn
and Lessard (1980) established that stock prices in many industrialized countries to be
negatively related to nominal interest rates and inflation.

Fama (1981) puts forth a large amount of evidence to validate the hypothesis that an unexpected
increase in the growth rate of real activity not only causes an increase in stock prices, but also a
decrease in the price level and inflation because of its impact on money demand. This author, in
his popular paper painstakingly observed that the results evidencing negative relations between
common stock returns and inflation were absolutely puzzling given that previously, common
stock, representing ownership of the income generated by real assets, should be a hedge against
inflation.
Pearce and Roley (1985) used money supply, inflation, real economic activity, and the discount
rate as explanatory variables in a study that sought to examine the response of stock prices to

18

announcements in the aforementioned time series in the USA. The empirical results from the
study indicated that monetary policy significantly affects stock prices. The researchers also found
that only limited evidence of an impact from inflation surprises, and no evidence of an impact
from real activity surprises on the announcement days. However, there seemed to be only weak
evidence of stock price responses to surprises beyond the announcement day. Wahid et al. (2011)
attempted to formulate the relationship between stock prices versus inflation levels. The outcome
from their empirical work revealed that the level of inflation affects share price index both in the
short-run and long-run.
Laopodis (2005) examines the dynamic interaction among the equity market, economic activity,
inflation, and monetary policy. Researcher looks into the first issue concerning the role of
monetary policy. Advance econometrics using cointegration, causality and error-methods using
bivariate and multivariate Vector Autoregressive (VAR) models. With bivariate results, they
found that the real stock returns-inflation pair weakly support negative correlation between stock
market and inflation, stock market can hedge against inflation. On the other hand, bivariate
results claims a negative and unidirectional relationship from stock returns to FED funds rate in
the 1990s but a very weak one in 1970s. With multivariate, they found strong support of shortterm linkages in the 1970s along with the same unidirectional linkage between the two in the
1990s. This showed that stock returns do not respond positively to monetary easing, which took
place during the 1990s, or negatively to monetary tightening. There were no consistent dynamic
relationship between monetary policy and stock prices. This conclusion seems to contradict
Famas (1981) proxy hypothesis, which said that inflation and real activity were negatively
related but real activity and real stock returns were positively related.

19

Joannides, Katrakilidis and Lake (2002) were investigating the relationship between stock
market returns and inflation rate for Greece over the period 1985 to 2000. There were arguments
that stock market can hedge inflation in line with to Fishers hypothesis. Another argument was
that the real stock market was immune to inflation pressures. This study attempted to investigate
the three types of relationship whether firstly the stock market had been a safe place for investors
in Greece.

2.3

Empirical literature

Empirical evidence classified the relationships into three types. First, there is positive
relationship between the stock market returns and inflation. They used ARDL co integration
technique in conjunction with Granger Causality to test the long-run and short-run effects
between the involved variables as well as the direction of these effects. There was a long run
negative relationship from inflation to stock market returns over the first sub-period. The
findings were consistent with Fama (1981). Bidirectional long run causality resulted in second
sub-period. There was a causal effect running from stock market returns to inflation. Evidence
also showed that a causal effect running from inflation to stock market returns in second subperiod. The second sub-period showed mixed relationship was also consistent with Spyrou
(2001).
Madsen (2004) used Fishers hypothesis to estimates the relationship between share returns and
inflation. Researchers have found that share returns are not hedged against expected inflation and
have interpreted this as evidence against the Fisher hypothesis. Fisher hypothesis were tested for
the process governing inflation, measurement of inflation expectations, and the time aggregation
of the data. The paper demonstrated theoretically and empirically standard tests of the Fisher
hypothesis can be directly misleading and often do not reveal much about the validity of the
20

Fisher hypothesis that would be explained by differences in model specification, time

aggregation of the data, inflation persistence in the data sample and whether instruments have
been used for expected inflation. The more persistent was inflation, the more favorable were
estimates which used nominal share returns as the dependent variable to the Fishers hypothesis.
The opposite result applies used real ex post share returns as the dependent variable, except in
the case where inflation expectations are measured by the actual rate of inflation. Furthermore,
tests were more favorable to the Fisher hypothesis when low frequency data and instruments for
expected inflation were used under the circumstances where nominal share returns were used as
the dependent variable.
Wei (2007) investigates the relation between unexpected inflation and stock returns. The study
showed correlations between unexpected inflation and nominal equity return of Fama-French
book-to-market and size portfolios across the business cycle. The study found four main finding.
Firstly, there was strong evidence that equity returns respond more negatively to unexpected
inflation during economic contractions than expansions. Secondly, equity returns of firms with
lower book-to-market ratio and medium size are more negatively correlated with unexpected
inflation. Third, the excess return was the only factor responded to changes in expected and
unexpected inflation. Meanwhile, the cross-sectional patterns of inflation betas across book-tomarket and size portfolios reflect their heterogeneous factor loadings on this common factor.
Lastly, the cyclical patterns of inflation beta would not explain based solely on how bond prices
react to unexpected inflation. The return on the 30-year government bond declines in response to
unexpected inflation and the magnitude of responses does not differ significantly across the
business cycle. It appears that information on future growth rates and risk premium were
important elements behind the cyclical patterns of inflation beta. The proxy of risk premium
21

raises more in response to unexpected inflation in recessions as compared to expansions,

contributing to the asymmetric inflation beta across the business cycle.
Merika and Anna (2006) re-examine Famas proxy hypothesis which states that inflation was
negatively related to real economic activity and the negative relationship between stock returns
and inflation reflects the positive impact of real variables on stock returns. The study tests the
hypothesis that stock prices respond negatively to positive real economic activity. The strong
economic activity causes inflation and induces policy makers implemented a counter cyclical
macroeconomic policy. Negative stock price responded to news of an improving economy was
justified if the expected effect of a contractionary policy was greater than the expected output
gain the news suggest. By VAR model test, employment appears to be significant while it exerts
a strong negative effect on stock returns. The reason for increase in employment forecasts
inflation which was expected to erode firms profits while expressed through falling stock
returns.
Al-Rjoub (2003) investigated the effect of unexpected inflation on stock returns in five MENA
countries: Bahrain, Egypt, Jordan, Oman, and Saudi Arabia. The researcher used Threshold
GARCH and Exponential GARCH to catch the news affect that unexpected inflation may have
on stock returns. The Exponential GARCH resulted the unexpected inflation had a negative
impact on stock market returns in all the MENA countries. The impact is high and significant in
Bahrain, Egypt, Jordan and Saudi Arabia and Oman. The leverage effect for Bahrain is negative
indicated the existence of the leverage effect in stock market return during the 1999:01 through
2002:07 sample periods. The impact is asymmetric. The leverage effect for Egypt is positive
indicated the non-existence of the leverage effect in stock market return during the 1999:01
through 2002:07 sample periods. Results were similar for Jordan. For Oman and Saudi Arabia
22

there was no news effect of inflation on stock market data. On the other hand, the Threshold
GARCH resulted unexpected inflation, a negative effect on Bahraini (-164.74 with P-value of
(0.00)), Jordanian (-92.28 with P-value (0.05)), and Saudi stock market return (-292.2 With Pvalue of (0.00)). The coefficients of unexpected inflation were negative and highly significant.
Only Oman and Egypt have shown insignificant results where unexpected inflation shows no
effect on stock market return data in the sample period. The study found negative and strongly
significant relationship between unexpected inflation and stock returns in MENA countries and
indicate the stock markets of the listed MENA countries does not feel the high ups and downs
movements in the markets. The asymmetric news effect was absent.
Kim and Ravi (2006) were explained the cross-sectional variation in the relation between
international security returns and expected inflation based on their sensitivities to world stock
and bond factors. The paper shows inflation sensitivities of returns on country indexes and
international mutual funds on their sensitivities to world stock and bond indexes. The result from
OLS regression coefficient for return sensitivity of stock to the stock market factor was negative
and significant at the five percent level. The coefficient for return sensitivity to the bond market
factor was positive and significant at the one percent level. Thus, the results support the
hypothesis that the inflation sensitivity of a security was negatively related to its stock market
return sensitivity and positively related to its bond return sensitivity. Concluded that the inflation
sensitivity of a security is positively (negatively) related to its sensitivity to the world bond index
(world stock index).
Al-Khazali (2003) investigated the generalized Fisher hypothesis for nine equity markets in the
Asian countries: Australia, Hong Kong, Indonesia, Japan, South Korea, Malaysia, the
Philippines, Taiwan, and Thailand. It states that the real rates of return on common stocks and the
23

expected inflation rate were independent and that nominal stock returns vary in a one-to-one
correspondence with the expected inflation rate. The results of the VAR model indicate the
nominal stock returns seem Granger-causally a priori in the sense that most of the forecast error
variances is accounted for by their own innovations in the three-variable system; inflation does
not appear to explain variation in stock returns; stock returns do not explain variation in expected
inflation. The stochastic process of the nominal stock returns could not be affected by expected
inflation. The study fails to find either a consistent negative response of stock returns to shocks
in inflation or a consistent negative response of inflation to shocks in stock returns in all
countries. The generalized Fisher hypothesis was rejected in all countries.
Another investigation from Al-Khazali (2004) explained the negative relationship between real
stock returns and expected inflation in the Jordanian economy. The study examines whether the
proxy-effect hypothesis can adequately explain the negative relationship the two variables. The
study contributed in validates the Fisher hypothesis for stock market returns of the several
developed economies; On the other hand, contributed in effectively to hedge against inflation in
Jordanian countries. The OLS result show that a negative relationship between expected inflation
and expected real stock returns. Meanwhile, the study was not support the proxy-effect
hypothesis for Jordanian economy.
Diaz and Jareno (2005) investigate the short run response of daily stock prices in the Spanish
market to the announcements of inflation news on each industrial sector. The aim was to study
the relationship between unanticipated inflation news and stock returns, focusing our analysis on
the sector of activity. The methodology based on time-series event-study methodology included a
large number of recent papers used these approach to analyze the repercussion of some
macroeconomic announcements on returns of different market indexes, interest rates or stocks.
24

The result shown coefficients of all sectors in the preannouncement period are not statistically
significant. No evidence of a significant relationship between abnormal returns and total inflation
during this period is found. The proximity to the announcement originates uncertainty in the
market but these abnormal returns were independent of the final amount of the total inflation
rate. In contrast to literature and the study was observe a significant positive relationship
between stock returns and inflation changes for the Spanish market as a whole and for several
sectors. Lastly, relationship between inflation rate and abnormal returns was negative in the postannouncement period, but the coefficient is statistically insignificant. There was no evidence of a
possible adjustment of prices subsequent to an overreaction on the announcement day.
Adrangi, Chatrath, and Sanvicente (2000) investigated the negative relationship between stock
returns and inflation rates in markets of industrialized economies for Brazil. The study found
there was negative relationship between inflation and real stock returns, the finding support
Famas proxy hypothesis framework. Real stock returns may be adversely affected by inflation
because inflationary pressures may threaten future corporate profits; and nominal discount rates
rise under inflationary pressures, reducing current value of future profits and lastly on stock
returns. The results support the interesting notion that the proxy effect in the long-run rather than
short run.
Schwert (1981) analyzed the reaction of stock prices to the new information about inflation. He
stated that the important reason to expect a relationship between stock returns and the
unexpected inflation was that unexpected inflation contained new information about future levels
of expected inflation. The unexpected inflation have variety of effects on the value of the firm,
and unexpected increase in expected inflation could cause government policy-makers to react by
changing monetary of fiscal policy in order to counteract higher inflation. He found that the
25

stock market seem not react to unexpected inflation during the period of Consumer Price index
was sampled on several weeks before the announcement date.
Saryal (2007) studied the impact of inflation on conditional stock market volatility in Turkey and
Canada. He examined the two questions. First, how does inflation stock market volatility
estimated by using nominal stock return series? Second, does the relation differ between
countries with different rates of inflation? The Canada and Turkey data were selected for
comparison on the basis of their inflation level. The reason of selected countries because Turkey
was an emerging market country with a high inflation rate and Canada a developed country with
a low inflation rate. The results suggest that the higher the rate of inflation, the higher the
nominal stock returns consistent with the simple Fisher effect. The result showed the rate of
inflation was one of the underlying determinants of conditional stock market volatility
particularly in a highly inflated country like Turkey. The variability in the inflation rate had a
stronger impact in forecasting stock market volatility in Turkey than in Canada.
Khil and Lee (2000) observed real stock return and inflation relations in the U.S. and 10 Pacificrim countries for the sample period of 1970 to 1997. In the study, they document a negative real
stock return and inflation correlation in nine Pacific-rim countries as well as in the U.S.
However, Malaysia was the only country that exhibits a positive relation between real stock
returns and inflation. Thus their study provided an empirical framework that attempts to
disentangle the sources of these correlations. There were several reasons that they were
interested in the stock return and inflation relation in the Pacific-rim countries. First, it was
become more important to understand financial markets in Asian countries. Second, while the
U.S. and European countries tend to experience mild inflation, Asian countries experience
widely different types of inflation. Third, the U.S. experience shows that the stock return and
26

inflation relation may be either positive or negative. Fourth, monetary authorities and their
policies in most Asian countries tend to be more prone to political influence than in the U.S.
Fifth, one of the hypotheses that explain the negative correlation between stock returns and
inflation was the tax hypothesis. The result show the relationship between real stock returns and
inflation appeared to be inconsistent with the predictions of the Fisher hypothesis and common
sense that common stocks should be a hedge against inflation but was in line with the post-war
experience of the U.S. and European countries. Malaysia was a country that exhibits a positive
relation between stock returns and inflation. In these countries, the real output disturbances drive
a negative between stock return and inflation relation, while monetary disturbances yield a
positive in stock return and inflation relation.
Kim and Iin (2005) investigated the Fisher hypothesis and its examination of the relationship
between stock returns and inflation by using the wavelet analysis and hence examine nominal
and real stock returns and inflation over the different time scales. They also investigate the
variances, covariance of nominal and real returns and inflation. Correlations and crosscorrelations between nominal and real returns and inflation were calculated for the different time
scales. On the other hand, the study also examines the long-run relationship between stock
returns and inflation not in real terms. The results of the regression analysis in the wavelet
domain and the wavelet correlation show that the relationship was positive at the short horizon.
Another results indicated that in all regression analyses, real returns have a significant negative
relationship with inflation except for the shortest time scale (d1) and the longest smooth scale
(s7) in wavelet analysis.
Lee (2009) reevaluate whether the stock return and the inflation relation indeed due to inflation
illusion by reexamining the hypothesis using longer sample period of the US and international
27

data. The inflation illusion hypothesis explained the post-war relation well; it was not compatible
with some features of the pre-war relation. A major problem is that while this hypothesis
anticipates under-pricing of stock prices with high inflation. Thus, the study observed the
overpricing with high inflation in the pre-war period.
According to Bekaert and Engstrom (2007), inflation illusion suggest that when expected
inflation rises, bond yields duly increase, but because equity investors incorrectly discount real
cash flows using nominal rates, the increase in nominal yields leads to equity under-pricing and
vice versa. Feldsteins (1980) variant of the inflation and stock market returns theoretical nexus,
suggests that inflation erodes real stock returns due to imbalance tax treatment of inventory and
depreciation resulting to a fall in real after-tax profit. Feldstein further observed that the failure
of share prices to rise during substantial inflation was because of the nominal capital gains from
tax laws particularly, historic depreciation cost (Friend and Hasbrouck, 1981).
According to Misati and Nyamongo (2010), Capital markets have grown substantially resulting
into an increase in the financial instruments on offer, and these developments have attracted the
interest of economic researchers and analysts who aim to investigate the factors that influence
the performance of the stock markets indices. Bordo et al.,(2008), while using latent Variable
VAR to estimate the impact of inflation and other macroeconomic variable on stock market
conditions, found that inflation have large negative impact on stock market conditions, apart
from their real effects on real asset prices. The study employed a hybrid model that allowed the
data to partly identify market conditions guided by their initial classifications of periods of
exceptionally rapid and prolonged increase in real stock prices as booms and periods of
significant declines as busts. (Reddy, 2012), contended that a reduction in inflation rate resulted

28

in increased stock prices. The author used a regression analysis which showed that the variable
accounted for up to 95.6% of the variations in stock prices for the period of 1997-2009.
Geyser and Lowies (2001) studied the impact of inflation on stock prices in two SADC
countries with the purpose of determining whether top performing companies that are listed on
the Johannesburg Securities Exchange and the Namibian Stock Exchange could provide a perfect
hedge against inflation. The study gave mixed results that restrained generalization on the
relationship between stock prices and inflation rates, where it emerged that only stock for mining
companies could provide a hedge against inflation.
Daferighe and Aje, (2009) analyzed the impact of inflation on the stock market performance in
Nigeria. The study depicted a weak negative correlated between the variables. The time series
data for a period of twenty years from 1991 to 2010 of the variables (market capitalization, total
value of shares traded, All-share index, turnover ratio and inflation) were used to measure the
regression coefficients of the respective variables. Evaluation of the impact of inflation on the
various measures, show that the greatest influence of 14.6% is on total volume traded ratio while
the least, is on percentage change in All-share index of 0.3% variation. This showed that the
effect of inflation on performance of Nigerian stock market is weak. All the measures show a
negative relationship to inflation except turnover ratio which showed a divergence from a priori
expectation as revealed by the positive correlation between inflation and the turnover ratio. The
inflation illusion hypothesis of Modigliani and Cohn (1970) points out, that the real effect of
inflation is caused by money illusion.

29

2.4

Literature on inflation and NSE in Kenya

Ouma, W.N and Muriu.P (2014) studied the impact of macroeconomic variables like inflation on
stock market returns in Kenya. The study has undertaken to empirically synthesize the
information to better understand the link between macroeconomic fundamentals and stock
returns. Based on the OLS results for the study, it revealed a positive impact of inflation (CPI) on
stock market returns for the ten year period between 2003 and 2013 investigated; this implied
that in Kenya stocks cannot be used as a hedge against inflation, since the positive regression
coefficient implies a higher expected return is required for higher inflation. The rationale for this
pattern is related to the inadequacy of hedging role of stock against inflation in Kenya. They
suggested therefore that the Central Bank of Kenya should impose its regulatory role to make
sure that rate of inflation in Kenya is kept within the range that would motivate investments since
the variable has a great impact on investors; the investors are faced with the decision as to
whether to make investments or not. Increase in inflation rate can cause the real income to
decline, when this happens, the investor end up selling their assets, including stocks to improve
their buying power. On the other hand, following from the coefficient of this variable, it can be
concluded that inflation in Kenya is within the desired or investor friendly levels; this is because
of the co-movement with the returns realized at the NSE.
Siele (2009) in the Study on the relationship between stock market and some selected
macroeconomic variables in Kenya used NSE 20 share index to represent Kenya Stock Market and
real GDP growth rate, inflation, interest and treasury bill rates as macroeconomic variables. Quarterly
time series data for the period 1999-2008 was analyzed using summary statistics, correlation and
regression analysis to ascertain the relationships. Findings of the study reveal that macro economic
variables explain about 70% of the variation of the market share index. The regression coefficients

30

show that the market share index is positively related to inflation rate, Treasury bill rate and gross
domestic product while it is negatively related to interest rate. This study results with similar views to
those of Kaimba (2010) and Kiptoo (2010).

Ngugi (2008) conducted a study on performance of NSE before and after the last four general
elections in Kenya namely 1992, 1997, 2002 and 2007.The NSE month end indices for the
period between 31st January 1991 and 30th September 2008 obtained from the NSE were
analyzed using line graphs, percentages, mean , variance and other statistical measures. The
study results indicate the NSE performance was influenced by the political activities and
expectations around the election period in the short term. The 19
study also reveals that the first two years after election performed better than the last 2 years
before the next general election.
Wambui B.N (2013) studied the effects of inflation on the performance of the NSE 20 share
index using monthly data on inflation and NSE 20 share index for the period of January 2002 to
December 2012. The study considered theories dealing with inflation and share prices and
evaluated empirical evidence from studies conducted in Kenya and around the world. The study
used secondary data which was analyzed through a simple linear regression model. The aim was
to establish a predictor model having the NSE 20 share index as the dependent variables and
inflation as the independent variable. Analysis of the variables used the SPSS program to
conduct tests on the data. Scatter diagram, descriptive statistics and simple regression models
were used in the analysis. The best fit line on the scatter diagram indicated there is no
relationship between the 2 variables. The value of R squared was 0 meaning there is no
relationship between the variables. The regression model developed is weak in predicting the
NSE 20 share index value. The study recommended that the government should aim at
31

controlling the inflation rate in Kenya by making it generally constant at a low level to attract
more investors in the NSE as it will make the investment environment predictable.

2.5 Summary of the gaps to be filled

Most researchers have focused their research on the performance of the Nairobi Securities
Exchange basing it on two variables; inflation and NSE 20-share index. Wambui B.N (2013)
failed to incorporate variables such as market capitalization and equity share turnover in his
research on the effects of inflation on performance of Nairobi Securities Exchange 20-share
index. More research should be carried out on how these two variables affect the performance of
the Nairobi Securities Exchange.

32

CHAPTER THREE

RESEARCH METHODOLOGY
2.1 Introduction
This chapter contains methods that were used in conducting the research study. It contains the
research design, population sample that may be used, the sample design and sample size, the data
collection methods used and the data analysis and how the data will be presented.

3.2 Research Design

The study was on the effect of inflation on the performance of the Nairobi Securities Exchange.
The research period was from the year 1990 to the year 2014.
This study adopted a correlation research design. This design perpetuated the understanding of
the relationships among the study variables. The effects of inflation on the performance of the
Nairobi Securities Exchange where its performance is measured through the various magnitudes
of market capitalization, equity stock turnover and NSE 20 share index.
3.3 Population
The population of the study was all the 64 companies listed on the Nairobi Securities Exchange
that had been split in sectors. The sectors are: Agricultural, Automobiles and Accessories,
Banking, Commercial and Services, Construction and Allied, Energy and Petroleum, Insurance,
Investment, Investment Services, manufacturing and Allied, Telecommunications and
Technology, and the Growth Enterprise Market Segment. The NSE has made the financial
information for all these companies public as part of the requirements by the CMA.
The inflation rate, equity share turnover, NSE 20-share index and market capitalization data
cover a period of 25 years, thereby having 25 entries that are yearly averages of each of the 25
years.
33

3.4 Sample Design& Sample Size

The study is done to conduct the effect of inflation on the performance of the NSE, Kenya.
Performance indicators of the NSE are considered to be the NSE 20-Share Index, Market
Capitalization and the Equity Share Turnover for companies listed on the NSE. The yearly
inflation rates were correlated to each data variable. Analysis was done on inflation against NSE
20-Share Index, Inflation against Market Capitalization, and Inflation against equity share
turnover.
3.5 Data Collection
The study used secondary data collected from KNBS annual inflation reports, NSE annual
market and stock reports and the CMA annual reports. The data was recorded in Minitab
Software v.17 for analysis.

3.6

Data Analysis & Presentation

Descriptive, correlation and regression analysis was conducted on the data to establish the
relation on the variables. This method was used by Kaimba (2010) in the study to establish the
causal relationship between stock market performance and economic variables.
The study applied the following regression model:
y = a + bx + e
Where;
x = Annual rate of inflation.
y = Performance variable of NSE (N20, Mc, Mt)
a = Constant
b= Measures the direction & rate of change of y, as a result of unit change in x
34

e = Error term.
The study had a significance level of 5%. The study tested the null hypothesis that there is no
relationship between the dependent variable and the independent variable. The study used tables
to present data.

35

CHAPTER FOUR
RESULTS AND DISCUSSIONS

4.1 Introduction
This chapter contains research results from data collected during the research process. The
statistical software used was MINITAB 17. It contains descriptive statistics, correlation analysis,
regression analysis and discussions on the effects of inflation on Market Capitalization, NSE 20Share index and Equity Share Turnover.

4.2 Descriptive Statistics

Descriptive statistics is a discipline of quantitatively describing the main features of a collection
of information or the quantitative description itself. The table above gives descriptive statistics
on the four variables during the period of study. The analysis is of four sets of variable namely
Inflation rate, NSE 20 share index, market capitalization and equity share turnover. Each variable
has 25 items representing the annual value for the 25 years of Study being from 1990 to
2014.The descriptive statistics measured are mean, median, maximum, minimum standard
deviation, skewneess and kurtosis

Table 4.1 Descriptive Statistics

Inflation
Mean
Median
Maximum
Minimum
Std Dev
Skewness
Kurtosis

11.88
9.8
46
1.6
9.85
2.12
5.3

NSE 20-Share
Index
3108
3115
5646
915
1400
0.06
-0.86

36

Market
Capitalization
493
137
2142
11
576
1.42
1.58

Equity Share
Turnover
42.7
6.2
215.7
0.2
58.5
1.5
1.81

From table 4.1, the mean of inflation data is 11.88, with the minimum being 1.60 and the
maximum being 46. The standard deviation is 9.85; this indicates a wide distribution of inflation
data over the period of the study. The inflation median is 9.8 which is close to the mean of 11.88
suggesting that the distribution is almost normal.
The mean of the NSE 20-share Index is 3108, with a minimum value of 915 and a maximum of
5646. The standard deviation is 1400, and the median is 3115. The median of 3115 is close to the
mean 3108, indicating that the distribution is close to a normal distribution.
The mean of the Market Capitalization is 493, with a minimum of 11 and a maximum of 2142.
The standard deviation is 576, and a median of 137. The median is not close to the mean; hence
the distribution is not close to a normal one.
The mean of the equity share turnover is 42.7, with a maximum of 215.7 and a minimum of 0.2.
The standard deviation is 58.5, and a median of 6.2. The median not being close to the mean
indicates that the distribution is not normal.
The results in our study differ from the results of Wambui B. N (2013). In her research on the
effects of inflation on performance of NSE 20 Share Index, she used monthly data in her
calculations while we used annual data. Her calculations and ours differ in several ways; her
mean of inflation is 8.86 while ours is 11.88. We also have higher maximum and minimum
values of inflation parameter. Our data seems to have a much wider distribution (STD deviation
9.85) than that of Wambui B.N (2013) which stands at 5.2637. Her distribution also is more
normal than ours due to having a less difference between her median and mean than ours.
The mean, minimum, median and maximum values of the NSE 20 share index of our study is
less than Wambui B.N(2013) findings, which were (3534.0401,1043.87335, 3597.3450 5774.27).

37

Our distribution of NSE 20 share index also seems to be wider than Wambui B.N (2013)s. Our
distribution is however much closer to a normal distribution due to the lesser difference between
the mean and median values than that of Wambui B.N (2013)
Figure 4.1: Inflation rate Time Series Plot
Time Series Plot of ANNUAL INFLATI ON RATE

ANNUAL INFLATION RATE

50

40

30

20

10

0
1990

1994

1998

2002
Year

2006

2010

2014

The Figure 1 above indicates the volatile nature of inflation in Kenya during the period of study.
The lowest point of inflation being at 1.60 and the highest at 46.The trend has been characterized
by general increase in level of inflation over specific years, followed by a decline in following
years. A general constant inflation rate was observed during the period of study.

38

Figure 4. 2: NSE 20-Share Index Time Series Plot

Time Series Plot of NSE 20-SHARE (Yearly Average)

NSE 20-SHARE (Yearly Average)

6000

5000

4000

3000

2000

1000
1990

1994

1998

2002
Year

2006

2010

2014

Observation from the Figure 2 indicate a general upward trend in the value of the NSE 20 share
index from the year 1990 to 1994, then a slump from the years 1995 to 2001. Then a sharp
increase during the years 2002 to 2006, followed by a slight decline then a general increase in the
value of the indices.
Figure 4.3: Equity Share Turnover Time Series plot

EQUITY SHARE TURNOVER (Billions

Time Series Plot of EQUITY SHARE TURNOVER (Billions

200

150

100

50

0
1990

1994

1998

2002
Year

39

2006

2010

2014

The Figure 3 shows a steady rise from the years 1990 to 2005, followed by a sharp increase in
the year 2006 to 2008. The period is then followed by a sharp decline, then a steady increase in
the years thereafter.
Figure 4.4: Market Capitalization Time Series Plot

MARKET CAPITALIZATION (Billions

Time Series Plot of MARKET CAPITALIZATION (Billions

2000

1500

1000

500

0
1990

1994

1998

2002
Year

2006

2010

2014

The Figure 4 above shows a steady increase in market capitalization from the years 1990 to
2002, followed by a slightly increased increase in growth level from the years 2003 to 2014.

40

4.3 Correlation Analysis

Correlation refers to the degree of relationship existing between two or more variables. The
variables may have a positive or negative correlation or they may be uncorrelated. It ranges
between -1 and 1.The table below shows the correlation between inflation and the NSE 20-share
index.
Table 4.2 Pearsons Correlation analysis Data Table
Pearsons
Correlation
Sig. (2-tailed)
P Value

NSE 20-Share
Index

Equity Share
Turnover

Market
Capitalization

-0.235

-0.258

-0.294

0.258

0.167

0.154

From table 4.1 above, the Pearson correlation coefficient of Annual Inflation rate and the 20share index is -0.235 with a two tailed significance level of 0.05 The Pearson correlation ranges
between -1 and +1. The value -0.235 indicates there is a weak relationship between the two
variables during the period of study. The P-value of NSE 20-share index is 0.258, which is
greater than the 0.05 significance level, suggesting that the independent variable is statistically
insignificant hence we accept the null hypotheses Ho: N20 = 0 that inflation has no effect NSE
20-Share Index.
According to Wambui B.N (2013) the correlation between inflation and NSE 20-share index is
-0.004.This showed a weak negative correlation. In this research, there exists a weak negative
correlation between inflation and NSE 20-share index of -0.235. Although both studies exhibit
almost similar results, the previous study portrays a stronger weak negative correlation compared
to the study at hand.

41

From the Table 4.1, the Pearson correlation coefficient of Annual Inflation rate and the Equity
Share Turnover is -0.285 with a two tailed significance level of 0.05. The value -0.285 indicates
there is a weak relationship between the two variables during the period of study. The P-value is
0.167, which is greater than the 0.05 significance level, suggesting that the independent variable
is statistically insignificant hence we accept the null hypotheses Ho: Mt = 0 that inflation has no
effect Equity Share turnover.
The results in table 4.1 on the correlation between inflation and equity share turnover differ with
a study done by Daferighe, E. E. and Aje S. O. (2009) that brought a correlation value of 0.298,
which depicted a weak positive correlation coefficient between the two variables. Their study is
in line with our findings that inflation has no effect on equity share turnover.
From the table 4.1, the Pearson correlation coefficient of Annual Inflation rate and the Market
Capitalization is -0.294 with a two tailed significance level of 0.05. The value -0.294 indicates
there is a weak relationship between the two variables during the period of study. The P-value is
0.154, which is greater than the 0.05 significance level, suggesting that the independent variable
is statistically insignificant hence we accept the null hypotheses Ho: Mc = 0 that inflation has no
effect Market Capitalization.
The results in table 4.1 on the correlation between inflation and market capitalization differ with
a study done by Daferighe, E. E. and Aje S. O. (2009) which brought a correlation value of
-0.411, which depicted a weak negative correlation between the two variables. Using t statistics
to test for significance of the independent variable, Daferighe (2009) concluded that inflation
has an effect on the market capitalization.

42

4.4 Regression Analysis

Regression refers to the relationship among variables by focusing on the relation
between the dependent variable and more than one independent variable. This chapter contains the
regression analysis, the interpretation and the discussion.

Table 4.3 Regression analysis data table

Regression Analysis

NSE 20-Share
Index

Equity Share
Turnover

Market
Capitalization

Constant

3505

62.8

697

Coefficient of Independent
variable(Annual Inflation Rate)

-33.4

-1.7

-17.2

1390.06

57.2646

562.091

2.3494

2.8548

2.9359

R2

5.52%

8.15%

8.62%

1.41

4.15

4.65

0.488684

0.345777

0.177251

F Statistics

1.34

2.04

2.17

t Statistics

-1.16

-1.43

-1.47

p value

0.258

0.167

0.154

Std. error

R2 Adj.
Durbin Watson

The table 4.2 above shows the regression analysis between the independent variable (Inflation)
and the dependent variables NSE 20-Share Index, Equity Share turnover and Market
Capitalization.
4.4.1 Effects of Inflation On NSE 20-Share Index
In the Table 4.2, the constant of the regression equation for NSE 20-Share index is 3505. This is
the value of NSE 20-share index when the inflation is zero. In our research, the value of R
Squared is 5.52% which is 0.0552. This figure indicates that inflation only explains 5.52% of the
total variation in NSE 20 share index. Hence it affects NSE 20 share index to a small extent. This
means that 94.48% of total variation is accounted by the disturbance term.
43

From the table 4.2, the value of the coefficient of the independent variable on the NSE 20-Share
index is -33.4. This shows what direction and by what magnitude NSE 20 share index will
change if inflation changes by a unit. The regression equation y=a+bx+e can therefore be
expressed as:
Y=3505-33.4x
The results differ from Wambui B.N (2013) research revealed that inflation has no effect on the
performance of the NSE 20 share (R2 =0.0000) while our research showed that inflation has little
effect on the performance (R2 =0.0552). Similar conclusions have been made using the Pearson
coefficient.
4.4.2 Effects of Inflation on Equity Share Turnover
In the Table 4.2, the constant of the regression equation for Equity Share turnover is 62.8. This is
the value of Equity Share turnover when the inflation is zero. In our research, the value of R
Squared is 8.15% which is 0.0815. This figure indicates that inflation only explains 8.15% of the
total variation in Equity Share turnover. Hence it affects Equity Share turnover to a small extent.
This means that 91.85% of total variation is accounted by the disturbance term.
From the table 4.2, the value of the coefficient of the independent variable on the Equity Share
turnover is -1.70. This shows what direction and by what magnitude Equity Share turnover will
change if inflation changes by a unit. The regression equation y=a+bx+e can therefore be
expressed as:
Y=62.8-1.70x
According to Daferighe, E. E and Aje, S. O. (2012), the research indicated that inflation is
responsible for 3.8% of the variation in annual equity share turnover of the Nigerian Stock
44

Market. The adjusted R2 coefficient 0.038 indicated that inflation accounted for 3.8% of the
variation in the influence on annual equity share turnover of the stock market. This research
indicates a higher adjusted R2 of 8.15 compared to the previous study
4.4.3 Effects of Inflation on Market Capitalization
In the Table 4.2, the constant of the regression equation for Market Capitalization is 697. This is
the value of Market Capitalization when the inflation is zero. In our research, the value of R
Squared is 8.62% which is 0.0862. This figure indicates that inflation only explains 8.62% of the
total variation in Market Capitalization. Hence it affects Market Capitalization to a small extent.
This means that 91.38% of total variation is accounted by the disturbance term.
From the table 4.2, the value of the coefficient of the independent variable on the Market
Capitalization is -17.2. This shows what direction and by what magnitude Equity Share turnover
will change if inflation changes by a unit. The regression equation y=a+bx+e can therefore be
expressed as:
Y=697-17.2x
According to Daferighe, E. E. and Aje, S.O (2012), the studies results revealed that inflation is
responsible for 12.3% variation in market cap of the Nigerian Stock market. The coefficient of
determination indicated that inflation accounted for 12.3% of the variation in the influence of
market cap of the stock market. This indicates a higher coefficient of determination compared to
this study.

4.5 General Discussion

The main objective of the study was to assess the effect of inflation on the performance of the
NSE market, determine the effects of inflation on the stock market turnover and analyze the

45

effects of inflation on the NSE 20-share index. Tests on correlation indicated that there is no
correlation between inflation and each of the other dependent variables NSE 20 share index,
Market Capitalization and Equity Share turnover. The model summary in each analysis also
confirmed to a 5% significance level that there is no relationship between the variables. We
therefore accept all the null hypotheses that inflation has no effect on market capitalization;
inflation has no effect on equity share turnover and inflation has no effect on NSE 20-share
index. This therefore means that inflation has no major impact on the performance of NSE,
Kenya.

CHAPTER FIVE
SUMMARY, CONCLUSION & RECOMMENDATION

5.1 Introduction
This chapter contains the summary of the findings, conclusion, recommendations and areas for
further research.

46

5.2 Summary of the findings

Inflation in Kenya has been unstable over the period of the study and also as shown in Figure 1,
where the highest value of inflation was 46.0 and lowest value was 1.60. The standard deviations
of inflation (9.85), market capitalization (576), and equity share turnover (58.5) indicate a
widened distribution of the time series data. Large difference between the median and mean of
market capitalization data and equity share turnover depicts that the distribution is not normal.
The distribution of time series data of NSE 20-Share index and inflation portray a normal
distribution due to the fact that the difference between the mean and the median is small.
Data from table 4.1 indicate that inflation has a weak correlation to the variables: NSE 20-Share
Index, Equity Share Turnover and Market capitalization. The p values are also greater than the
significance level (0.05) depicting that the inflation is statistically insignificant in affecting the
performance of the NSE performance variables hence we accept all the null hypotheses:
HO: Mc = 0: Inflation has no effect on market capitalization (Mc)
HO: Mt = 0: Inflation has no effect on stock market turnover (Mt)
HO: N20 = 0: Inflation has no effect on the NSE 20 share index (N20)
The regression coefficients depict that inflation accounts for a very small percentage of change in
the total variation of the NSE performance variables. Inflation accounts for only 5.52% change in
the NSE 20-share index, an 8.62% change in the Market capitalization and 8.15% for changes in
Equity Share Turnover. Inflation also has a negative coefficient in each of the dependent
variables.

47

5.3 Conclusion
The observation from the analysis of data in previous chapter indicates that there is a very
insignificant relationship between inflation and the NSE 20 share index, market capitalization
and equity share turnover. Graphical presentation of the inflation and the NSE 20 share index,
market capitalization and equity share turnover in the period of study indicates a general inverse
relationship among the three variables in the long run in the period from 1990 to 2014.
The results of the study indicate that inflation risk represented by x in the regression model
Y=a+bx+e has insignificant effect on the NSE performance represented in the model by Y. The
indicators; market capitalization, equity share turnover and NSE 20 share index has helped the
study in assessing, determining and analyzing the effects of inflation on NSE performance.
5.4 Recommendations
The research done focused on the Nairobi Securities Exchange because it is the only established
securities exchange in Kenya. The analysis of inflation on performance of security exchange
companies in Kenya is therefore limited to this single company, which may be inadequate, but
will have to do. Further studies should be done based on share pricing theories on the impact of
investors perception to the news of inflationary levels and figures. For the time being, investors
are encouraged to invest in Kenya because the inflation levels will not affect the value of their
investment.

5.5

Areas for further research

According to this research Inflation accounts for a small percentage change in the variables that
affects the performance of the NSE. The research should include other macroeconomic factors.
Hence further research should be undertaken to include these macroeconomic factors which have
a significant influence on the performance of the NSE, Kenya.
48

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APPENDIX I

YEAR
1990

ANNUAL
INFLATION
RATE
15.80

MARKET
NSE 20-SHARE CAPITALIZATION
(Yearly Average)
(Billions Kshs)
915
10.90
51

EQUITY SHARE
TURNOVER
(Billions Kshs)
0.23

1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014

19.60
27.30
46.00
28.80
1.60
9.00
11.20
6.60
5.80
10.00
5.80
2.00
9.80
11.79
9.87
6.04
4.26
15.10
10.54
4.08
14.00
9.40
5.72
6.88

958
1167
2514
4559
3469
3114
3115
2962
2303
1913
1675
1087
1935
2640
3972
5646
5445
3521
3247
4257
3751
3736
4784
5017

APPENDIX II
NAIROBI SECURITIES EXCHANGE KENYA
LISTED COMPANIES
Agricultural
Eaagads Ltd Ord 1.25
52

12.71
23.00
72.00
136.80
107.20
98.68
114.31
128.94
106.74
101.42
98.40
83.30
180.65
274.41
420.70
791.60
851.10
853.70
834.20
1089.20
1035.80
1072.90
1691.50
2142.40

0.30
0.38
0.82
3.08
3.34
3.96
6.15
4.58
5.12
3.63
3.80
2.02
7.51
20.35
22.03
94.90
88.60
97.50
38.20
103.50
98.10
86.80
155.80
215.70

Kapchorua Tea Co. Ltd Ord 5.00

Kakuzi Ord.5.00
Limuru Tea Co. Ltd Ord 20.00
Rea Vipingo Plantations Ltd Ord 5.00
Sasini Ltd Ord 1.00
Williamson Tea Kenya Ltd Ord 5.00
Commercial And Services
Express Ltd Ord 5.00
Kenya Airways Ltd Ord 5.00
Nation Media Group Ord. 2.50
Standard Group Ltd Ord 5.00
TPS Eastern Africa (Serena) Ltd Ord 1.00
Scangroup Ltd Ord 1.00
Uchumi Supermarket Ltd Ord 5.00
Hutchings Biemer Ltd Ord 5.00
Longhorn Kenya Ltd
Telecommunication and Technology
Access Kenya Group Ltd Ord. 1.00
Safaricom Ltd Ord 0.05
Automobiles and Accessories
Car and General (K) Ltd Ord 5.00
Banking
Barclays Bank Ltd Ord 0.50
CFC Stanbic Holdings Ltd ord.5.00
I&M Holdings Ltd Ord 1.00
Diamond Trust Bank Kenya Ltd Ord 4.00
Housing Finance Co Ltd Ord 5.00
Kenya Commercial Bank Ltd Ord 1.00
National Bank of Kenya Ltd Ord 5.00
NIC Bank Ltd 0rd 5.00
Standard Chartered Bank Ltd Ord 5.00
Equity Bank Ltd Ord 0.50
The Co-operative Bank of Kenya Ltd Ord 1.00
53

Insurance
Jubilee Holdings Ltd Ord 5.00
Pan Africa Insurance Holdings Ltd 0rd 5.00
Kenya Re-Insurance Corporation Ltd Ord 2.50
CFC Insurance Holdings
British-American Investments Company ( Kenya) Ltd Ord 0.10
CIC Insurance Group Ltd Ord 1.00
Investment
Olympia Capital Holdings ltd Ord 5.00
Centum Investment Co Ltd Ord 0.50
Trans-Century Ltd
Manufacturing and Allied
B.O.C Kenya Ltd Ord 5.00
British American Tobacco Kenya Ltd Ord 10.00
Carbacid Investments Ltd Ord 5.00
East African Breweries Ltd Ord 2.00
Mumias Sugar Co. Ltd Ord 2.00
Unga Group Ltd Ord 5.00
Eveready East Africa Ltd Ord.1.00
Kenya Orchards Ltd Ord 5.00
A.Baumann CO Ltd Ord 5.00
Construction and Allied
Athi River Mining Ord 5.00
Bamburi Cement Ltd Ord 5.00
Crown Berger Ltd 0rd 5.00
E.A.Cables Ltd Ord 0.50
E.A.Portland Cement Ltd Ord 5.00
Energy and Petroleum
Kenol Kobil Ltd Ord 0.05
Total Kenya Ltd Ord 5.00
KenGen Ltd Ord. 2.50
54

Kenya Power & Lighting Co Ltd

55