CHAPTER FOUR THE METHODOLOGY 4.

1 Introduction the study aims at investigating the various factors that influence the variability of the stock price of various industrial subsectors. In economic literature, money supply, interest rate (represented by minimum rediscount rate), exchange rate and inflation rate (represented by composite consumer price index) are recognized as the major determinants of stock prices. Shiller (1989) indicated that the performance of a firm will be affected by the behavior of price that affects the price of its shares in the market. Also the stock of money supply is expected to affect the level of economic activities such as the aggregate level of output and thus, lead to growth in output, prices movements in money demand, aggregate expenditure and investment. This process is expected to affect the activities of the money and capital markets and hence share price movements (Merton, 1980). Moreover, the behavior of interest rates also influences share prices (Officer, 1973). The basic underline factor here is that a rise in interest rate will raise the cost of fund which

encourage firms to source fund by going to the stock exchange market. Among the external factor that serves as the main determinants of stock price is exchange rate. The underlying economic theories postulate a positive relationship between inflation rate and the nominal value of stocks (Shiller, 1989). This positive relationship also hold for money stock and price but the relationship between interest rate and stock price seems ambiguous in the literature. In terms of exchange rate, we expect a positive relationship between devaluation and share prices. In addition to the general stock price, we also focused on sectoral stock prices in order to determine the differential impact of these macroeconomic indices on each identifiable sector or industry. Also the possibility of lag in the stock price movement leads to the inclusion of lagged-value in the analysis (Amoye, 1995). 4.2 The Model Specification The model is specified in a multiple regression equation form. The literature review guided our choice of independent variables as discussed earlier. Stock price movement as the

dependent variable, while interest rate, exchange rate, inflation ate, money supply and the lagged value of the stock price are the independent variables. The model is thus specified as follows: SPt = Xt + et Where SPt is the stock price of sub-sector t(t=1,10) and the overall stock exchange index SPN. similarly, Xt represents the vector of independent variables where the subscripts denote different sub-sectors within the sectors. The various sectoral dependent variables are deined as follows: SPF = Share price of the financial sector SPA = Share price of the auto machinery and equipment sector SPP = Share price of the petroleum marketing sector SPc = Share price of the chemical, paints and building sector SPcp = Share price of the containers, packaging and papers sector

SPFB = Share price of the food, beverages and tobacco sector SPPT = Share price of the pharmaceutical and toiletries sector SPE = Share price of the engineering and construction sector SPCG = Share price of the conglomerates sector SPT = Share price of the textiles and footwear sector SPN = Nigerian stock exchange index (NSE stock Index) This sectoral classification becomes necessary in order to evaluate the impacts of the independent variables or regressors on each sub-sectors share price behavior. This would further serve as the basis of comparison. The vector of independent

variables comprises each subsectors lagged value of share price (SPt-1), inflation rate (Infrate), money supply (MONSS), interest rates (MRR) and exchange rate (EXCRATE). Explicitly, the empirical model is specified as: SPt = 0 + 1INFRATE +2MONSS + 3MRR +4EXCRAATE + et

Moreover, the lag operator is introduced in order to capture the response lag of dependent variables and the determinant influence of lagged-value of share price on the dependent variables. Also, the preliminary empirical estimate of equation 4.3 reveals the presence of a specific pattern of serial correlation and the effects of mis-specification in the model. This is shown by low values of Durbin-Watson (DW). As indicated in the literature, among the possibilities of the modification of the model are the introduction of new regressors, and the introduction of some dynamic elements using lags of existing or additional variables (Stewart, 1991). The model is thus specified in a dynamic form by explicitly including the lag-value of the share price of the each sub-sector. That is, SPt = 0 + 1SPt-1 + 2INFRATE + 3MONSS + 4MRR + 5EXCRATE + et Where, 1>0, 2>0, 3>0, 4>0, and 5>0 and 0 is a constant term, while et is an error term assumed to be identically and independently distributed with zero men and constant variance. The empirical model therefore consists of 22 equations.

The main equations useful for this analysis are equation 4.3 (static equation) and equation 4.4 (dynamic equation). In the static form, the empirical equation is thus specified as follows: SPft = a0 +a1MRR +a2INFRATE +a3EXCRATE +a4MONSS +et ..4.3.1 SPAT = b0 +b1MRR +b2INFRATE +b3EXCRATE +b4MONSS +et..4.3.2 SPpt = c0 +c1MRR +c2INFRATE +c3EXCRATE +c4MONSS +et..4.3.3 SPct = d0 +d1MRR +d2INFRATE +d3EXCRATE +d4MONSS +et..4.3.4 SPcpt = e0 +e1MRR +e2INFRATE +e3EXCRATE +e4MONSS +et..4.3.5 SPFbt = f0 +f1MRR +f2INFRATE +f3EXCRATE +f4MONSS +et...4.3.6 SPPTt = g0 +g1MRR +g2INFRATE +g3EXCRATE +g4MONSS +et...4.3.7

SPEt = h0 +h1MRR +h2INFRATE +h3EXCRATE +h4MONSS +et...4.3.8 SPcGt = i0 +i1MRR +i2INFRATE +i3EXCRATE +i4MONSS

+et...4.3.9 SPTt = j0 +j1MRR +j2INFRATE +j3EXCRATE +j4MONSS

+et...4.3.10 SPNt = k0 +k1MRR +k2INFRATE +k3EXCRATE +k4MONSS +et...4.3.11 The dynamic model of equation 4.4 is thus specified as follows: SPft = a0 + a1SPPt-1 + a2MRR + a3INFRATE +a4EXCRATE +a5MONSS + et ..4.4.1 SPAT = b0 + b1SPPt-1 + b2MRR + b3INFRATE +b4EXCRATE +b5MONSS + et..4.4.2 SPpt = c0 + c1SPPt-1 + c2MRR + c3INFRATE +c4EXCRATE +c5MONSS + et ..4.4.3 SPct = d0 + d1SPPt-1 + d2MRR + d3INFRATE

+d4EXCRATE+d5MONSS + et ..4.4.4

SPcPt = e0 + e1SPPt-1 + e2MRR + e3INFRATE +e4EXCRATE +e5MONSS + et ..4.4.5 SPFbt = f0 + f1SPPt-1 + f2MRR + f3INFRATE +f4EXCRATE +f5MONSS + et ..4.4.6 SPPTt = g0 + g1SPPt-1 + g2MRR + g3INFRATE +g4EXCRATE +g5MONSS + et ..4.4.7 SPEt = h0 + h1SPPt-1 + h2MRR + h3INFRATE +h4EXCRATE+ 8h5MONSS + et ..4.4.8 SPcGt = i0 + i1SPPt-1 + i2MRR + i3INFRATE +i4EXCRATE +i5MONSS + et ..4.4.9 SPTt = j0 + j1SPPt-1 + j2MRR + j3INFRATE +j4EXCRATE +j5MONSS + et 4.4.10 SPNt = k0 + k1SPPt-1 + k2MRR + k3INFRATE +k4EXCRATE +k5MONSS + et ..4.4.11 4.3 Type and source of Data The data used for the study was collected from several sources. For example, the macroeconomic indices were extracted from the publications of the Federal Office of Statistics and the CBN. The Stock price data were collected from the annual reports

of the Nigerian Stock Exchange and the Securities and Exchange Commission. As indicated earlier, the composite consumer price index (CPPI) was the proxy used for the inflation rate, hile the minimum re-dicount rate of the CBN represented the interest rate. The general and sectoral stock price indices published by the Nigerian securities and exchange commission served as the dependent variable for each regression equation. All data series are on monthly basis which allows for adequate degree of freedom thereby preventing the regression analysis from been

constrained. We use 60 data observations for each sub-sector. All the data set used for the analyses are show in the appendix.

CHAPTER FIVE THE EMPIRICAL ANALYSIS 5.1 The Interpretation of Regression Results In econometric theory, the acceptable values of the DW statistics should range between 1.75, and 2.25, while 2.0 being he ideal. A causal observation of the results of equation 4.3 reported in table 5.1 shows that DW values ranged from a minimum value of 0.33 in equation 4.3.3 to a minimum value of 1.35 in equation 4.3.6. All the results (R2) have high of adjusted these coefficient coefficients of are

determination

and

many

statistically significant at the 1% and 5% significance levels which is less that -1.67 (at critical value of 0.05) and less that -2.33 and greater than 2.33 (at critical value of 0.01) are therefore taken as evidence that the coefficients are not zero, therefore the null hypothesis is rejected. But, the value of DW is low which indicates the specification error and the possibilities of omitted variables in the model. The equation is therefore modified to include the lag-value of share price in equation 4.4., the results of which are reported

on Table 5.2. Superficially, there is a considerable improvement in the DW statistics as well as an increase in the number of coefficients with statistically significant t-values. The DW

statistics now range between a minimum of 1.87 and maximum value of 2.08. This shows the absence of any material autocorrelation problem that could affect the analysis. In equation 4.4.1, the share price of the financial sub-sector, is made to depend on it lag-value, money supply, interest rate, exchange rate and money supply. The result shows some striking fact. The R2 is extremely high at 0.970 compared to 0.920 in equation 4.3.1 but both inflation rate and money supply are not significantly different from zero, while interest rate and exchange rate are statistically significant. The DW statistics also improved to the value of 2.03. In all the sectors, the regressors have considerable impacts on the regressand. In equation 4.4.2, the R2 value of 0.968 clearly shows that 96.8% of the variability in nominal share price of Auto-machinery and equipment sub-sector is explained by the chosen regressors. However, only two t-values, those of interest rate and money supply are statistically significant at 1% and % level respectively.

Across

all

the

equation,

the

most

prominent

and

consistently significant variable is the lag-value of nominal stock price. This clearly shows that the lag-value of share price is a major determinant of its current value. The coefficient of the lagvalue has very high t-value, suggesting that there is very close association between the present and lag-value of nominal share price. The interest rate coefficient has a negative sign in al the equations except equation 4.7 for the Pharmaceutical and TOileteries sub-sector as well as the overall NSE stock index. Furthermore, noen of the t-values in both cases in statistically significant. His indicates that, this variable validates the

theoretical expectation in all other sub-sectors, but in all these three sub-sectors, the a priori expectation is violated. This variables coefficients are also significant at the 1% critical value in the financial and the containers, packaging and paper subsectors. It is also significant at the 5% level with respect to food, Beverages and tobacco; Textile and Footwear sub-sectors, and for the overall and NSE stock index. The exchange rate coefficients also have positive signs in all sub-sectors except equations 4.4.6 and 4.4.7 and 4.4.11. this

shows that exchange rate coefficients violate the theoretical expectation in all the sub-sectors with negative coefficients. The coefficients are significant at the 1% level in respect of equation 4.4.1 and 4.4.5 and at the 5% level in equation 4.4.8 Money supply also has a positive correlation with the share price of all sub-sectors as shown in table 4.2. The theoretical plausibility is entrenched but the coefficients are significant only in equation, 4.4.2, 4.4.3, 4.4.4, 4.4.6, 4.4.9 and 4.4.11. But in others, money supply is not a significant variable that affects the share prices. Certain inferences can be drawn from this analysis. Only the lag-value of nominal stock index and money supply have significant coefficients and positive influence in the NSE stock index. But, while this fact holds for some sub-sectors, it is not for others. This clearly portrays the fact there is possibility of fallacy of composition when considering the impacts of regressors on the general stock index. Also at the sub-sector level, what may be good for goose, may not be good for gander. Therefore, it is highly justified that the evaluation of all the variables as a policy instrument is best judged at the sub-sector level.

5.2

The Policy Implication of the Regression Analysis The basic policy implication that can be drawn from this

analysis is as follows. All the regressors interest rate, exchange rate, money supply, inflation and the lag-value of nominal stock price, have differential impacts across the sectors. But, in all, there is one dominant factor; all the current nominal stock prices in all sub-sectors have a positive and significant correlation with their lag-value. This clearly portrays the fact that, the influence of past value of share price is a major determinant of the current nominal share price. Moreover, the deregulation of the economy has had a considerable impact on the share prices in all sub-sectors but in the different direction. The significant effect of money supply on the stock price movement shows the potential efficacy of monetary policy. If monetary policy is properly designed and implemented, it can be an effective instrument for influencing and controlling stock price movement. But, all these assertions are best considered and evaluated via their influence on different sub-sectors share price.

The usefulness of exchange rate policy as a policy instrument to influence share price is greatly in doubt in this analysis. Exchange rate policy have implications for targeting economic activities via the financial variables. But, this is applicable only in financial, pharmaceutical and toiletries and engineering and construction subsectors as it is a significant variables influencing their share prices. Even, it is not a significant variable in the general stock price movement. Finally, the dynamic specification of the stock price

equation is theoretically justified and empirically validated. In the industrial sector, the static specification of this relationship between the dependent and the explanatory variables would lead to auto-correlation, specification errors and the possibility of omitted variable bias.

CHAPTER SIX SUMMARY OF FINDINGS, RECOMMENDATION AND CONCLUSIONS 6.1 Summary of Major Findings This study has examined the effect of selected

macroeconomic variables, such as interest rates, inflation rates, exchange rates and money supply, on the movements of the prices of stocks of various sub-sectors and the overall price index of the Nigerian Stock Exchange. The major findings and observations from the analysis are summarized as follows. First, the findings show that all the policy variables have differential impact across the sectors analyzed. For example, while interest rate has a positive relationship with the share price of Pharmaceutical and Toiletries, Textile and footwear and the NSE Stock Index, it had a negative influences on the stock price of the her sub-sectors. Also money supply has a positive influence across all the sectors. This contrasts with the inflation rate which was found to have a positive sign in respect of only three sectors. Financial, food, beverages and tobacco as well as engineering and

construction. In addition, interest rate also displayed mixed results across sectors. While it relates positively in respect of only three sectors, it negatively affects stock rice movements in respect of seven sectors. Overall, only interest rate and exchange rate have negative relationship with the overall index o the NSE. However, from the analysis, the most prominent variable is the lagged-value of nominal stock prices of each sector. This variables is statistically significantly in all the sectors and for the overall NSE stock price index. 6.2 Recommendations Based on the results of the analysis of this study, the following recommendations are suggested to aid capital market growth and development in Nigeria. First, it is important to note that stock price measures the health of organizations and investors perception of their expected returns. It is therefore recommended that great care should be taken by capital market policy makers, stock brokers and issuing houses to ensure appropriate pricing of stocks in the Nigerian Capital Market. Secondly, since the macroeconomic variables of interest rate, inflation rate, money supply and exchange rate have

differential impact on he sectors studied, efforts should be made by policy makers and others involved in pricing to take this into consideration when fixing stock prices. It is also recommended that policy-makers should be cognizant of the potential

differential reaction of the different sectors of the stock exchange to macroeconomic policy decision, given the implications for resource allocation among and within the different sectors of the economy. In this wise, the process of determining share price appreciation on the floor of the Nigerian stock exchange should also be looked into. The present situation in which a minimum price gain of 20kobo is fixed for all equities in a given trading day fails to capture the differential impact of the variables analysed on the equities of various sectors. In view of this, it is recommended that price movements should be allowed to reflect the peculiarities of each sector. The maximum gain ceiling of 20 kobo is inconsistent with this principle, and should be rectified forthwith. Moreover, monetary policy should be well designed and implemented as this can be an effective instrument for

influencing and controlling stock price movement in the Nigerian Capital Market.

Finally, the fact that the lagged value of nominal stock services has the most significant positive influence on the NSE stock index and the different sectors price movement has implications for the free operations of the NSE. The observed result might be due to the deliberate fixing of prices or ceiling on price movements; suggesting that the much-taunted

deregulation of the NSE is still a mirage. It may also distort the expected random behavior of stock prices in a free or

deregulated stock exchange. It is therefore recommended that policy makers describe a better means of ensuring the market based determination of prices in the NSE and thereby remove distortions in share price behavior. The above mentioned recommendations are by no means exhaustive. However, they will go a long way in enhancing investors; confidence in the Nigerian capital market, boost the growth, the development and aid the internalization of the Nigerian capital market. 6.3 Conclusion This study has observed that stock prices variability in the Nigerian Capital Market are influenced by interest rate, inflation

rate, exchange rate, money supply and the lagged value of nominal stock prices. The regressors have differential impact across the various sectors of the Nigerian Capital Market and the NSE Stock index. The major inference that can be drawn from the analysis is that, the lagged-value of nominal stock price have the most significant and positive influence on the stock price movements in the Nigeria Capital Market. This observation is similar to that of Amoye (1994) used average stock prices, the official NSE price index was used in this study. The

disaggregation into sectors is also more informative and will enhance the appropriativeness of macroeconomic policy design as well as individual investment decisions.