Relationship Between Financial Deepening Indicators And Stock Market Performance In Kenya

Abstract

Financial deepening indicators play a big role in the stock market performance. The relationship between financial deepening and the economic growth in various economies is a well-documented subject but the relationship between financial deepening indicators and the stock market performance has little literature. The purpose of this study therefore was to find out the relationship between financial deepening indicators and the stock market performance in Kenya. The selected financial deepening indicators were financial savings, private sector credit, broad money supply and intermediation ratio on the stock market performance. For this, published quarterly time series data from January 2001 to June 2017 were obtained from the Central Bank and Kenya National Bureau Statistics. Financial savings (in trillions), private sector credit (trillions) and broad money supply (billions) were normalized using quarterly GDP. The intermediation ratio was computed as private sector credit/financial savings and multiplied by 1000 to normalize to the other data. Exploratory research was used to establish the relationship between the variables and as a pre-test analysis, data was tested for stationarity using the DF and Phillip-perron test and the data was found to non-stationary, it was then differences to be order I(1)- which is a requirement for cointegration. Johansen cointegration test was done indicating that the variables co-move towards a long-run equilibrium, a multivariate vector error correction model was run and the estimates obtained. The error correction term was also computed. Empirical results showed that all variables are adequately explained by their own lags and the lags of the other variables,the coefficients are also significant. The error correction model indicated that an increase in private sector credit by one unit in the previous quarter causes the stock market performance to increase by 48% in the current quarter. Variance decomposition tests and impulse response functions indicated how other variables respond to shocks in the other variables and the forecast errors for each of the predicted quarters. The implication of this study is that the policy makers who are; the Government, the Central bank of Kenya and the Capital Markets Authority ought to make policy decisions while considering the effect of the full market. This study concluded that private sector credit is the financial indicator variable that affects the stock market performance the most with a bidirectional relationship. The areas of further study include; comparative studies within the East African countries, use of models that test the volatility of the stock market and application of other indicators of financial deepening.