Inflation And Stock Market Returns In Nigeria: An Empirical Analysis

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Inflation And Stock Market Returns In Nigeria: An Empirical Analysis


This study examined empirically the impact of inflation on Nigerian stock market returns, within the period 1985 – 2012. Further the study investigated the influence of money supply, real GDP, interest rate and exchange rate on the returns of stock market. Secondary data was acquired from the NSE for stock market returns while for inflation, money supply, exchange rate, interest rate and GDP was obtained from CBN. The data was collected and analysed using Stata version 12.0 and the result of the analysis presented in tables. The correlation results revealed a strong positive correlation for the stock market returns and the CPI. The results for the Philips- Perron test for unit roots showed time series for returns of the stock market and inflation were stationary after differencing them once. ARDL long-run regression findings showed that there is a positive but insignificant connection of inflation and stock market returns. The findings also revealed negative long-run connection for the real exchange rate and stock market returns and between real rate of interest and the stock market returns. Positive long-run connection was found between real supply of money and returns of stock market and between real GDP and returns of stock market at the NSE. ARDL short-run results showed that inflation rate positively influences stock market return at the NSE. The results also showed that real money supply do have strong positive influence on stock market returns at the NSE. The rest of the variables, real exchange rate, real rate of interest and real GDP does not have any significant influence on stock market returns at NSE for the short-run. The investigation revealed that economic growth is the most important determinant of stock market returns in Nigeria in the long-run. The study recommended that the government should ensure that there is a stable macro-economic environment which will ensure high economic growth rate in the country. This will enable high returns to the investors in the stock market and spur further growth in different sectors of the economy.

Table Of Contents

Preliminary Page(s)

  • Title Page
  • Declaration
  • Approval
  • Dedication
  • Acknowledgement
  • Abstract
  • Table of Content

Chapter One:


  • 1.1 Background of the Study
  • 1.2 Research problem
  • 1.3 Research Objective
  • 1.4 Relevance and significance of the Study
  • 1.5 Scope of the study
  • 1.6 Limitation of the study
  • 1.7 Organization of the study

Chapter Two:

Literature Review

  • 2.1 Introduction
  • 2.2 Theoretical Review
  • 2.3 Conceptual review
  • 2.4 Summary of Literature Review

Chapter Three:

Research Methodology

  • 3.1 Introduction
  • 3.2 Research Design
  • 3.3 Data Collection
  • 3.4 Data Analysis

Chapter Four:

Data Analysis, Results and Discussion

  • 4.1 Introduction
  • 4.2. Descriptive Statistics
  • 4.3 Correlation Analysis
  • 4.4 Phillips-Perron Test for Unit Roots
  • 4.5 Post-Estimation Diagnostic Tests
  • 4.6 Co-integration Analysis
  • 4.7 Regression Results of the Long-run ARDL Model
  • 4.8 Short-Run Dynamic Regression Results
  • 4.9 Interpretation of the findings

Chapter Five:

Summary, Conclusion and Recommendations

  • 5.1 Introduction
  • 5.2 Summary of the Findings
  • 5.3 Conclusion
  • 5.4 Policy Recommendations
  • 5.5 Limitations of the study
  • 5.6 Suggestion for further research
  • References

Chapter One


1.1 Background Of The Study

A common problem plaguing the growth of developing countries like Nigeria is the shallow nature of its financial markets both in terms of breadth and depth. Indeed financial markets play an important role in the process of economic growth and development by facilitating savings and channeling funds from savers to investors. While there have been numerous attempts to develop the financial sector, emerging markets like that of Nigeria are also facing the problem of macroeconomic variable fluctuations and unpredictability in numerous fronts – arising from fluctuations in inflation, exchange rate and changing levels of financial openness – including volatility of its financial sector.

The degree of stock market return and volatility if known can help forecasters predict the path of an economy’s growth and attendant volatility levels. The structure of fluctuations and volatility can imply that investors now need to hold more stocks in their portfolio to achieve diversification. This case is more serious for relatively small (compared to developed economies) and emerging economies like Nigeria who is currently attempting to further deepen its financial sector by developing its securities market. Unlike mature stock markets of advanced economies, the stock markets of less developed economies like Nigeria began to develop rapidly only in the last two decades, and are sensitive to factors such as changes in the levels of economic activities, changes in the political and economic environment as well as changes in general macro economic variables.

To date economic theory and empirical studies consider stock prices, stock returns and numerous other macroeconomic variables as the best indicators of changes in the market index and stock market returns in any economy. This intellectual curiosity gained ascendancy in the last two decades due to the increasing belief that real economic activities often impact on stock prices and returns in the stock market (Osamwonyi and Evbayiro-Osagie,2012). For instance, Chen Roll and Ross (1986) argued and empirically showed that movements in macroeconomic variables affect future dividends as well as discount rates, thus affecting stock prices. Smith (1990), in his study of the American stock price behaviour, observed that stock prices usually decline shortly (on average, for months), before a recession begins and rise shortly before a recession ends. Changes in consumption and investment opportunities are priced in capital markets, hence stock price changes are related to innovations in economic variables (Goswami and Jung 1997). There exists a long-term relationship between the changes in stock prices (and returns) and the macroeconomic variables. Fama (1981, 1990) and Chen et al. (1986) tested the relationships with the US economic data. Fama (1981) documents a strong positive correlation between common stock returns and real economic variables like capital expenditures, industrial production, real GNP, money supply, lagged inflation and interest rates. Chen et al. (1986), found that changes in aggregate production, inflation, short-term interest rates, the maturity risk premium and default risk premium are the relevant economic factors.
Inflation and stock returns are two crucial indicators of a country’s economy. An analysis of stock market returns and inflation connection is vital since a change in stock prices due to inflation influences the decisions of both the firms and investors. Despite many studies in the same field, it has not be ascertained whether inflation and the returns of stock market have a positive or negative connection (Eita, 2014). Persistent inflation impacts on the prices of stock and the eventual returns and the performance of other stock market indices (Ogunmuyiwa, 2015). Major macroeconomic factors including money supply, interest rates, Gross domestic Product, inflation and exchange rate determine stock returns. Rising variations in exchange rates, inflation, money supply and interest rates increases stocks returns’ volatility resulting in more risks which compels the investors to switch their investments to portfolios which are less risky such bonds ( Kirui, Wawire & Onono, 2014).

Some hypotheses have been formulated to demonstrate on how inflation and stock prices are connected. Depending upon the theory under consideration, stock prices can be affected by inflation either positively or negatively. Fisher (1930) opined that shares can be used as a shield to the inflation where a growth in the expected inflation results in a similar shift in the nominal share returns. However, Proxy theory by Fama (1981), asserts that the returns of stock market are negatively influenced by inflation since real activity and stock returns are positively linked and a negative association exists between real activity and changes in price levels. The theory further suggests that the real rate of returns is unaffected by inflation since equities are a good hedge against inflation (Floros, 2003).

Most stock markets in developing countries, greatly contribute to the mobilization of economic resources both locally and globally so that to increase the economic potential of a country (Aliyu, 2011). As an economic institution, NSE has a fundamental responsibility in ensuring the enhancement of capital formation and allocation efficiency. Thus, level of efficiency and performance of the stock market determines the overall development of an economy (Kirui, Wawire & Onono, 2014). Volatility of stock markets threatens economic growth and efficient allocation of resources. It erodes investor confidence and can slow down the economic growth of a country (Amata, Muturi & Mbewa, 2016). Therefore, the study seeks to investigate and examine how inflation affects the performance of the NSE and can be used to provide decision making platform for both the policy makers and individual investors.

1.2 Research problem

Inflation has a diverse effect across the economic spectrum in any country. For instance, inflation will impact on the cost of conducting business. Inflation affects analysts, investors, economists and policy makers. A country’s economy could totally be derailed by inflation. It affects the stock market which greatly contributes to economic growth.

Stock returns volatility disrupts smooth function of NSE because it reduces the investors’ confidence. There has been an upward and downward trend in the NSE share index. The unstable nature of the NSE results in an over-sensitivity of stock returns to macro- economic factors. According to Kimani and Mutuku (2013), an increase in inflation makes goods expensive because it raises their prices. This will lead to decrease in consumption levels in the economy thereby reducing the profits of companies, and also their respective share prices at the NSE. This will weaken the performance of the stock market. Stable stock prices would attract investors and improve the performance of NSE.

Several investigations have been done in the surrounding of US, Lintner (1975), Schwert and Fama (1977), Fama (1981), Modigliani and Cohn (1979), Roll and Geske (1983)) and European economies (Asprem, 1989). The negative effect of inflation on real stocks was evident from these studies, but did not elaborate the inflation influence to the stock market returns. Uwubanmwen and Eghosa (2015) explored the inflation rate impact on Nigerian stocks market returns. The study sorted to establish the influence of inflation on

Nigerian stocks market returns and to determine the extent to which the stock prices can be used to predict market returns. A negative insignificant association was found between the rate of inflation and stocks return meaning inflation isn’t effective in predicting the Nigerian stock returns. Alagidede (2009), explored the connection the stock prices have to inflation and noted a positive connection for inflation and the stock returns in Nigeria. However, Mutuku and Ng’eny (2015) in their research of association of macro-economic factors and the Nigerian stock market found a negative link between NSE performance and Inflation.

The different studies highlighted above yielded different findings which could be due to different sets of variables applied, varying methodologies among other factors. The varying results of this matter necessitate the need for more insight on the connection that inflation has on stock market return. The study poses the question: What is the effect of inflation on stock market returns at the Nigerian Stock Exchange?

1.3 Research Objective

To establish the effect of inflation on stock market returns at the Nigerian Stock Exchange.

1.4 Relevance And Significance Of The Study

There are several compelling needs for undertaking this study. It will update existing body of knowledge by going a step forward to evaluate the awareness and effect of macroeconomic variables on Nigerian stock exchange returns and stock prices in general on the Nigerian bourse. It is therefore expected that the findings of this study will be of immense benefit to policy makers in Nigerian publicly quoted organizations, relevant government institutions, researchers and numerous other stakeholders. As was mentioned earlier, very few empirical studies have been conducted in Nigeria to find out specifically how inflation (in isolation from other macroeconomic variables) affects stock market returns in general .

To the policy makers, the study will point out the next direction in which economic reform should focus upon in other to position and direct Nigerian capital market towards the right path of effectiveness and efficiency especially in the area of resource utilization as well as depth and breadth of the market. The relevant government institutions will find the study beneficial in the sense that it will enhance their understanding of the workings of the Nigerian capital market.

Other relevant stakeholders like shareholders, members of the Boards of Directors who formulate policies, managers and junior staff who implement the policies formulated by top management, fund providers (who would want their monies paid to them when their bills falls due); and customers of publicly quoted firms (and potential public firms as well) who desire an efficient, stable and virile stock market and economy in general will find the study very beneficial. Besides, the findings of this study will lay foundation for other academia and research students to carry-out further research related to this study. The findings of this study, may also serve as very useful springboard for related studies in Nigeria and some other less developed countries (LDCs) or added experience for some others.

1.5 Scope Of The Study

The scope of this study will be limited to Nigerian capital market with special reference to the stock prices of all publicly quoted firms via the Nigerian stock exchange All Share Index. To this end adequate data on inflation and stock prices (and returns) for the period 1985 to 2012 was obtained. The only restriction imposed was that data must have been available for the specified period of time.

1.6 Limitation Of The Study

The sample size considered in this study is too small and also the sample is non-random and hence, it may be biased, while also possibly excluding other macroeconomic variables that may best be appropriate to help capture the effect of macroeconomic variables on stock market returns and prices. Besides, the fact that we resorted to the use of secondary data implies that we are faced with the biases and imperfections that plague the use of secondary data worldwide.

1.7 Organization Of The Study

This study is organized into five chapters as follows: chapter one provides the background of the study, stating its objectives, hypothesis, the scope of the study, and the limitation of the study. A review of relevant literature was carried out in chapter two. The focus of chapter three is the research methodology with emphasis on model specification, estimation techniques, data collection and data requirement. Chapter four is concerned with data analysis as well as the various data presentation techniques to be used. The summary and conclusions from the study, recommendations offered and suggestions for further studies is covered in chapter five.

Chapter Five

Summary, Conclusion And Recommendations

5.1 Introduction

This chapter presents the summary, conclusions and recommendations of the findings of the study. This study examined the effect of inflation on stock market returns in Nigeria using quarterly data of time series over the period 2000-2016 using ADRL approach to cointegration to analyse the data.

5.2 Summary Of The Findings

The objective of the study was to determine the effect of inflation on stock market returns at the NSE. Quarterly data from 2000 to 2016 was collected from NSE for the stock market returns and from CBN for inflation, money supply, GDP and exchange rate.

Correlation analysis was done for all the variables. The result show a strong positive correlation between the stock market returns and CPI. A strong positive correlation between stock market returns and real money supply and real GDP is also revealed. The results show a significant negative connection of stock market returns and real rates of interest. Real rate of exchange however, had a positive but not significant correlation with stock market return.

The variables were tested for unit roots using Phillips-Perron test and the results revealed only one variable real interest rate was stationary at 5 percent level of significance. Other factors were found to be stationary after differencing them once.

Holding other factors constant, regression findings of the long-run ARDL reveals that at 1 percent significance level, the connection between real exchange rate and stock market returns in the long-run is negative. There is also a negative long-run relationship between real interest rate and stock market returns. The long-run relationship between real money supply, real GDP and stock market returns revealed a positive relationship. The results for inflation showed an insignificant positive connection with stock market returns in Nigeria.

ARDL short-run regression results revealed Nigeria’s stock market returns is positively influenced by inflation. And holding other variables constant, the short-run results revealed a positive influence of real supply of money on returns of stock market in Nigeria. Real rate of exchange, real rate of interest and real GDP however, does not significantly in the short-run affect stock Nigeria’s market returns.

5.3 Conclusion

The study aimed to explore empirically the influence of inflation on stock market returns at the NSE as well as other variables likely to influence the returns of the stock market. In order to achieve the objectives, this study used CPI as a proxy for inflation. By using modern econometric techniques such as Phillip-Perron unit root test in order to evade the problem of spurious outcomes that arise due non-stationary data. Using bounds testing technique to cointegration to approximate the long-run connection and short-run dynamic connection of the model. The findings of this study demonstrated a cointegration relationship between the stock market returns and the explanatory variables included in the model.

The regression result revealed that real interest rates, real rate of exchange, real money supply and real GDP influence stock market returns in the long-run. While the short-run model revealed that only inflation rate and real money supply positively influences stock market returns. The results however revealed that economic growth in a country is the most important determinant of the long-run stock market returns. The estimated coefficient of the error correction term in the short-run regression model was relatively low implying that the adjustment process towards equilibrium is slow, hence explaining the significance of lagged terms.

5.4 Policy Recommendations

The government should ensure that there is a stable macroeconomic environment which will ensure high economic growth rate. This will not only attract more investments in the economy, but will also ensure high returns to the investors in the stock market, this will spur further growth in different sectors of the economy. The government should also ensure that it improves the living standard of the people by providing important social amenities that will improve the potential of the people to invest and save in the stock market.

The regulator should ensure compliance with the policies and regulations by the market players to make sure there is success and productivity of the stock market. The managers of the economy should implement the macroeconomic variables regulations that are good for the development of the stock market as this study evidently show that changes in the inflation trigger movements in the stock market.

5.3 Limitations Of The Study

This investigation relied on data which was acquired from the NSE, and CBN. It was mainly secondary data. This is the first limitation since secondary data may be subject to errors, being out of date, inaccurate and incomplete.
The other limitation was the cost. The cost of getting the raw data was so high. Also the cost of printing and binding the document was very expensive. Time was also limited for data collection, data analysis and for completing the project on time.

5.6 Suggestion For Further Research

The stock market can be very sensitive to the peace and stability of a country. A study that focuses on influence of political stability on stock market returns should be conducted at the NSE.

Behavioural factors can also be studied to determine if they have any impact on the stock market returns in a country. Governance and corruption indices can be used to determine the influence they have on the stock market returns. Further studies can be done in other countries in the East Africa region using different methodology, time period and annual data instead of quarterly data.

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