Return volatility and equity pricing: a frontier market perspective

Journal article published in Social Science Research Network (SSRN) available at SSRN: http://ssrn.com/abstract=2520737 or http://dx.doi.org/10.2139/ssrn.2520737Using both monthly and weekly return series between 1999:01 and 2013:12, we investigate the dynamics of stock returns and volatility in a Kenya’s fledgling equity market – the Nairobi Securities Exchange. Both the GARCH-in-mean and E-GARCH models yield positive and significant conditional variance parameters. We also find that shocks to equity returns of conditional volatility are highly persistent. Our results also indicate that conditional variance is driven more by the past conditional variance than it is driven by new disturbances. Finally, we find evidence of volatility clustering in the stock markets around major world and domestic economic episodes. Results are consistent with the inference that investors require larger risk premia on equities if they anticipate greater price volatility in future.Using both monthly and weekly return series between 1999:01 and 2013:12, we investigate the dynamics of stock returns and volatility in a Kenya’s fledgling equity market – the Nairobi Securities Exchange. Both the GARCH-in-mean and E-GARCH models yield positive and significant conditional variance parameters. We also find that shocks to equity returns of conditional volatility are highly persistent. Our results also indicate that conditional variance is driven more by the past conditional variance than it is driven by new disturbances. Finally, we find evidence of volatility clustering in the stock markets around major world and domestic economic episodes. Results are consistent with the inference that investors require larger risk premia on equities if they anticipate greater price volatility in future

Effect of Regulatory Components on Volatility of Petroleum Pump Prices in Kenya

Volatility of petroleum pump prices in Kenya has continually affected its economic growth. Almost all other sectors of the economy growth rely on the petroleum products and therefore its instability in price leads to poor planning of other sectors. Expected profits by the companies who planned when the prices were favourable becomes affected leading to losses.  Those who do not incur losses results to increasing the prices of goods and services making the costs of living increase and therefore lowering the social economic growth. This paper is an extract from the completed research on drivers of instability in prices of petroleum products in Kenya (Munyua & Ragui, 2013). The main objective is to find out how the regulatory component affects the volatility of petroleum oil prices in Kenya. Keywords: Price regulation, Volatility, Pump prices, Petroleum products

Foreign exchange risk and the flow of international portfolio capital: evidence from Africa's capital markets

This dissertation addresses two major issues. First, it investigates whether currency risk commands a significant premium in representative equity markets in Africa. The International Arbitrage Pricing Theory and the Stochastic Discount Factor model respectively provide the analytical frameworks for the unconditional and the conditional asset pricing models used to investigate currency risk pricing. Empirical data analysis uses the Generalized Method of Moments estimation technique. Second, it examines the nexus between real foreign exchange rates and net international portfolio flows in representative capital markets in Africa. Time series and panel data techniques are employed to this end. The study covers seven major African countries: Botswana, Egypt, Ghana, Kenya, Morocco, Nigeria, and South Africa over the period January 1997 through December 2009. Foreign exchange risk is found to be non-priced unconditionally when returns are measured in the US dollar; weakly priced unconditionally when returns are measured in the euro; and priced with time-varying risk premia in the conditional sense. Africa’s equity markets are found to be partially integrated with the rest of the world. Monthly international portfolio flows to Africa are found to be low, non-persistent and relatively volatile. Using monthly data, Granger causality tests and innovation accounting from vector autoregressions (VARs), the study shows that the dynamic relationship between the real exchange rates and net portfolio flows is both country-dependent and time-varying. The findings are robust to alternative VAR specifications. However, annual data exhibit strong causality moving from real exchange rates to net portfolio flows, suggesting that fluctuations in real exchange rates inform the investment decisions of foreign investors in Africa’s capital markets. Among the key policy implications, it is recommended that, in addition to the US dollar and precious metals, Africa’s monetary authorities should regard the euro as an important reserve currency; that policies be put in place to expedite the development of private fixed income securities and derivatives markets; that sound monetary policies be instituted to ensure that interest rate changes are market-determined and inflationary pressures are well-managed; and that regional markets integration and financial sector development policies be pursued more meticulously by governments in Africa

The conditional pricing of currency and inflation risks in Africa's equity markets

Globalization of financial markets has increased correlation among developed economy markets and made developing economy markets attractive for diversification purposes. Among the developing economy markets are African equity markets, which appear to be the most promising and yet the least studied. Taking the perspective of foreign investors, we estimate the stochastic discount factor (SDF) model for a cross-section of major equity markets in Africa over the period 1997-2009, using the Generalized Method of Moments (GMM). Our findings suggest that real exchange rate risk constitutes a significant time-invariant component of returns in Africa’s equity markets. We also find that inflation and nominal exchange rates are separately priced, with time-varying risk premia. Given these findings, international equity investors interested in Africa should hedge their positions against currency risk. Accordingly, African governments should prioritize the development of hedging instruments to increase their equity markets’ investability

Capital structure, profitability and firm value: panel evidence of listed firms in Kenya

This paper investigates the relationship between leverage and the financial performance of listed firm in Kenya. We use annual data for the period 2002 – 2011. Using various panel procedures, our study finds reasonably strong evidence that leverage significantly, and negatively, affects the profitability of listed firms in Kenya. However, leverage has no effect on Tobin’s Q, our proxy for firm value. Our results are robust to alternative panel specifications and hold for both small-size and large-size firms. Second, because the performance of firms depends on other things than just their capital structure, we control for the effects of those other variables by including them in our models. In this respect, our findings suggest that asset tangibility, sales growth and firm size are important determinants of profitability. Surprisingly, asset tangibility consistently has a negative relationship with profitability. For small firms, our results indicate that sales growth and firm size are important factors driving firm value (Tobin’s Q). Yet, the same variables do not appear to drive the value of large firms

Capital structure, profitability and firm value: panel evidence of listed firms in Kenya

This paper investigates the relationship between leverage and the financial performance of listed firm in Kenya. We use annual data for the period 2002 – 2011. Using various panel procedures, our study finds reasonably strong evidence that leverage significantly, and negatively, affects the profitability of listed firms in Kenya. However, leverage has no effect on Tobin’s Q, our proxy for firm value. Our results are robust to alternative panel specifications and hold for both small-size and large-size firms. Second, because the performance of firms depends on other things than just their capital structure, we control for the effects of those other variables by including them in our models. In this respect, our findings suggest that asset tangibility, sales growth and firm size are important determinants of profitability. Surprisingly, asset tangibility consistently has a negative relationship with profitability. For small firms, our results indicate that sales growth and firm size are important factors driving firm value (Tobin’s Q). Yet, the same variables do not appear to drive the value of large firms

Exchange rate uncertainty and international portfolio flows: A multivariate GARCH-in-mean approach

This paper examines the impact of exchange rate uncertainty on different components of net portfolio flows, namely net equity and net bond flows, as well as their dynamic linkages. Specifically, a bivariate VAR GARCH-BEKK-in-mean model is estimated using bilateral monthly data for the US vis-à-vis Australia, Canada, the euro area, Japan, Sweden, and the UK over the period 1988:01-2011:12. The results indicate that the effect of exchange rate uncertainty on net equity flows is negative in the euro area, the UK and Sweden, and positive in Australia. The impact on net bond flows is also negative in all countries except Canada, where it is positive. Under the assumption of risk aversion, the findings suggest that exchange rate uncertainty induces a home bias and causes investors to reduce their financial activities to maximise returns and minimise exposure to uncertainty, this effect being stronger in the UK, the euro area and Sweden compared to Canada, Australia and Japan. Overall, the results indicate that exchange rate or credit controls on these flows can be used as a policy tool in countries with strong uncertainty effects to pursue economic and financial stability

The impact of firm size and liquidity on the cost of external finance in Africa

Established illiquidity measures are constructed for emerging markets in Africa and used to determine which best explains trading costs. Costs of equity are derived from an augmented Capital Asset Pricing Model for a sample of emerging financial markets generally ignored in the literature. These include: South Africa and Namibia, three countries in North Africa and four in Sub-Saharan Africa (SSA), plus London and Paris as examples of integrated markets. Minimum variance portfolios are constructed and asset weights derived, with the sample divided into countries dependent on their legal regime. Portfolio weights are shown to be directly related to well-regulated markets with high standards of corporate governance and disclosure, and firms seeking cost-effective finance from SSA stock markets are at a distinct disadvantage compared with those in Northern Africa, South Africa and, in particular, London and Paris

International portfolio flows and exchange rate volatility in emerging Asian markets

This paper investigates the effects of equity and bond portfolio inflows on exchange rate volatility using monthly bilateral data for the US vis-a-vis seven Asian developing and emerging countries (India, Indonesia, Pakistan, the Philippines, South Korea, Taiwan and Thailand) over the period 1993:01-2015:11. GARCH models and Markov switching specifications with time-varying transition probabilities are estimated in addition to a benchmark linear model. The evidence suggests that high (low) exchange rate volatility is associated with equity (bond) inflows from the Asian countries toward the US in all cases, with the exception of the Philippines. Therefore, capital controls could be an effective tool to stabilise the foreign exchange market in countries where flows affect exchange rate volatility