ABSTRACT
This study investigated the relationship
between volatility in the United States economy and capital markets, and the
Nigerian capital market and economy alike. The aim being to determine if the
Nigerian bourse is volatile and if it is significantly affected by the current
global economic meltdown (using data from the United States as proxies). Using
secondary data for the period December, 1990 to December, 2008, the study made
use of multiple regression analysis and the extension of Engle (1982) ARCH
model, which is the GARCH model, developed by Bolerslav (1986). The study found
positive and significant relationship between volatility in the United States
economy (and bourse) and volatility in the Nigerian economy (and bourse). The
result also discovered that the level of volatility was higher in the Nigerian
bourse and that the level of Nigeria’s economic performance is not
significantly determined by the level of volatility in the Nigerian bourse
though, a weak relationships exist. Because of this weak relationship and
significant effects of external stocks on Nigeria’s economy and bourse in
particular. It is recommended that the Nigerian economy be properly diversified
in such a way that it does not depend upon only one source of revenue. Also,
policy makers are advised to be careful in their use of the Nigerian bourse as
a barometer to reflect performance in the general economy as our findings
suggests that this could lead to misleading conclusions. Finally, we recommend
an improvement in the depth and breadth of financial products currently
obtained in the Nigerian bourse.
CHAPTER ONE
INTRODUCTION
1.1
BACKGROUND TO THE STUDY
Numerous empirical studies have appeared in
recent years concerning the volatility of stock market returns. Indeed a wide
variety of research has been conducted on stock returns volatility in both
developed and emerging markets since the 1970’s in which the nature of
volatility in different markets at different point in time were uncovered; and
financial economists during this period have been able to determine the causes
and variables behind the existence, nature and anomalies relating to market
volatility. More recently, the volatility of stock market prices and returns on
the Nigerian stock market has been a major concern to investors, analysts,
brokers, dealers and regulators. Stock return volatility has severally been
defined as a representation of the variability of stock price changes
(perceived by many as a measure of risk). Variability also refers to the degree
to which financial prices fluctuate. Large volatility means that returns (i.e.
the relative price changes) fluctuate over a wide range of outcomes. The
understanding of the level of volatility in a stock market will naturally be
useful in the determination of the cost of capital and in the evaluation of
asset allocation decisions. Policy makers therefore rely on market estimates of
volatility as a barometer of the vulnerability of financial markets (Olowe,
2009). However, the existence of excessive volatility, or “noise” in the stock
market undermines the usefulness of stock prices as a “signal” about the true
intrinsic value of a firm, a concept that is core to the paradigm of the
informational efficiency of markets (Karolyi, 2001).
The traditional measure of volatility as
represented by variance or standard deviation is unconditional and does not recognize
that there are interesting patterns in asset volatility: e.g., time-varying and
shoestring properties. Researchers have introduced various models to explain
and predict these patterns in volatility. Engle (1982) introduced the
autoregressive conditional heteroskedasticity (ARCH) to model volatility. Engle
(1982) modeled the heteroskedasticity by relatiing the conditional variance of
the disturbance term to the linear combination of the squared disturbances in
the recent past. Bollerslev (1986) generalized the ARCH model by modeling the
conditional variance to depend on its lagged values of disturbance, which is
called generalized autoregressive conditional hetereskedasticity (GARCH). Some
of the models include IGARCH originally proposed by Engle and Bollerster
(1986), GARCH-in-mean (GARCH-M) model introduced by Engle, Lilien and Robins
(1987), the standard deviations GARCH model introduced by Taylor (1986) and
Schevert (1989), the EGARCH or Exponential GARCH model proposed by Nelson
(1991), JARCH or Threshold ARCH and Threshold GARCH were introduced
independently by Zakoian (1994) and Gilosten, Jajanoathan, and Runkle (1998),
the power ARCH model generalized by Ding, Zhvanzin, C.W.J. Granger, and R.F.
Engle (1993) among others.
If investors are risk averse, theory predicts
a positive relationship should exist between stock return and volatility (Leon,
2007). If there is a high volatility in a stock market, the investors should be
compensated in form of higher risk premium. The GARCH-in-mean (GARCH-M) model
introduced by Engle, Lilien and Robbins (1987) has been used by various
researchers to examine the relationship between stock return and volatility
(see French, Schwert and Stambough, 1987; Cheu, 1989) while some others found it
negative (Nelson, 1991; Colosten et al, 1993 among others). Little or no work
has been done on modeling stock returns volatility in Nigeria particularly
using GARCH models (Olowe, 2009).
Furthermore, the term “global economic
meltdown” (with its pervasive effect) on many economies, is increasingly
becoming a topical issue in many developing and emergent economies in recent
time. It currently is used to refer to a financial crisis that is currently
plaguing much of the advanced world with increasing levels of spillovers into
the economies of developing nations. The current global financial crisis which
was triggered by the credit crunch within the US sub-prime mortgage market, is
continuing to spread and deepen in several countries. Countries around the world
have approached this whirlwind pragmatically, prompting emergency funding
support for relevant sectors, thereby mitigating the impact of the crisis on
economies as well as avoiding the entire collapse of the international
financial system. In spite of such support, some countries have been officially
declared as being in recession, owing to a monumental decline in their wealth,
manifesting itself in falling productive capacity, growth, employment and
welfare (Ajakanye and Fakiyes, 2009).
The global financial crisis of 2008, an
ongoing major financial crisis, could have affected stock volatility. The
crisis which was triggered by the sub-prime mortgage crisis in the United
States became prominently visible in September, 2008 with the failure, merger,
or conservatorship of several large United State – based financial prime
exposed to packaged sub-prime loans and credit default swaps issued to insure
these loans and their issuers (Wikipedia, 2009). The crisis rapidly evolved
into a global credit crisis, deflation and sharp reductions in shipping and
commerce, resulting in a number of bank failures in Europe and sharp reductions
in the value of equities (Stock) and commodities worldwide (Wikipedia, 2009).
The financial crisis created risks to the broad economy which made central
banks around the world to cut interest rates and various governments implement
economies stimulus packages to stimulate economic growth and inspire confidence
in the financial markets. The financial crisis dramatically affected the global
stock markets. Many of the world’s stock exchanges experienced the worst
declines in their history, with drops of around 10% in most indices (Wikipedia,
2009). In the US the Dow Jones industrial average fell 3.6%, not falling as
much as other markets (Olowe, 2009). The economic crisis even caused some
countries to temporarily close their market (Wikipedia, 2009).
The purpose of this study is to determine if
the Nigerian economy is affected significantly by the current global economic
meltdown, with the aid of secondary data collected between the periods of 1990-2008.
Specifically our aim is measure the level of volatility in the Nigerian bourse
for the specified period of time. Also this study sought to determine if the
level of volatility in the Nigerian bourse is significantly determined by the
level of volatility in the American economy using United States gross domestic
product (GDP) and the Dow Jones Industrial Average (DJIA) as proxies for
reflecting the effect of the global economic meltdown on the Nigerian economy.
Lastly, the study also sought to determine if there is a significant
relationship between Nigeria’s economy performance and its level of stock
market volatility.
1.2 STATEMENT OF RESEARCH PROBLEMS
Over the last few months the Nigerian
regulatory authority where of the opinion that the Nigerian economy was totally
insulated and free from the global financial meltdown and praised such softy
programmes as the recent banking industry reform and consolidation programme,
the on-going power sector reforms and indeed the seven (7) point agenda of the then
current administration (see Soludo, 2008 CBN 2008). Yet it stands to common
sense that no economy in the world can exist effectively in isolation as they
must of a necessity have to trade with other nations. This trade could be in
the form of good for good (Barker system), services for services or the normal
typical trade which will naturally involve foreign exchanges. Some nations may
even further depend upon one or a few core commodities in other to raise the
much needed foreign exchange which will be used to settle its transaction in
international scale and some of a great part of their external reserve may be
managed by institutions based in some countries, seriously affected by the
current global economic meltdown. Such a scenario will naturally lead to high
degree of risk as there is the logical reasoning that the features of such
economies and their institutions (positive or negative) will seriously impact
(or affect) the local economy (of a country) whose reserve is domiciled there.
Against this background, our foray into this
continuous issue is aimed at determining the general effect of the global
financial meltdown on the Nigerian economy and more specifically, with respect
to its effect on stock market volatility in Nigeria. Specifically, these
problems are: What effects will happenings in the US economy have on Nigerian
local economy What effects would the direction of movement of the US Dow Jones
Industrial Average have on the Nigerian bourse What effect would volatility
level in the US economy have on the level of volatility in the domestic
(Nigerian) economy What effect would the economic performance in the US bourse
have on Nigeria’s economic performance
1.3 STATEMENT OF RESEARCH QUESTIONS
Specifically, the following research
questions are posed:
Is the Nigerian stock market volatile?
Is volatility in the Nigerians stock market a
result of the volatility in the United States stock market?
Is there a relationship between Nigeria’s
economic performance and the economic performance of the US?
Is there a relationship between Nigeria’s
economic performance and its level of stock market volatility?
1.4 OBJECTIVES OF THE STUDY
i. To ascertain if the Nigerian stock market
is volatile;
ii. To determine if the level of volatility
in the Nigerian stock market is as a result of the volatility in the US stock
market;
iii. To ascertain if there is a relationship
between Nigerian’s economic performance and the US economic performance;
iv. To determine if there is a relationship
between Nigeria’s economic performance and its level of stock market
volatility.
1.5 HYPOTHESES OF THE STUDY
The hypotheses to be tested will provide
answers to the research questions and as well assist in dealing with issues
raised in the research problems and objectives. The hypotheses are stated in
the null form as follows:
Ho1: That there is no significant
relationship between the Nigerian economic performance and stock market
volatility in Nigeria.
Ho2: That there is no significant
relationship between the Nigerian economic performance and the United States
economic performance.
Ho3: That there is no significant
relationship between the Nigerian economic performance and the United States
stock market (Dow Jones Industrial Average) volatility.
1.6 SCOPE OF THE STUDY
The scope of this study will be limited to
the Nigerian capital market with special reference to the level of stock price
movements in the Nigerian bourse, data on United States Dow Jones Industrial
Average (DJIA) as well as United States Gross Domestic Product(USGDP). The
study will also utilize data concerning the Nigeria stock market all share
index and the Nigerian Gross Domestic Product (NGDP). Hence, all data will be
collected for the period 1990-2008.
1.7 SIGNIFICANCE OF THE STUDY
The Nigerian stock market has changed greatly
over the last decade. This is basically as a result of the various capital
market reforms that have been implemented over the years. This has led to an
increase in the level of activities in the stock market. The significance of
the study is of two fold namely practical and theoretical significance.
Practically, this study will be useful not only in the Nigerian Stock Exchange
but also to other financial institutions that may be opportune to lay hands on
a copy of this study. Theoretically, the study will be useful to scholars as
well as researchers, the findings of the study can generate researchers
interest on different area of the impact of global financial crisis, which will
enrich the literature of the impact of global financial crisis stock market
volatility and the Nigerian economy.
1.8 ORGANISATION OF THE STUDY
The study is organized into five chapters as
follows, chapter one provides the background to the study, statement of the
research problems, objectives of the study, hypotheses, the scope of the study,
the significance, the organisation, and the limitation of the study. Chapter
two contain the review of related literature from various authors, journals and
newspapers. The forms of chapter three is the research methodology with
emphasis on model specification, sample and sampling techniques, analytical
tools, data collection and data analysis Chapter four is concerned with data
analysis as well as the various data presentation techniques to be used. The
summary and conclusion from the study, recommendations offered and suggestions
for further studies is covered in chapter five.
1.9 LIMITATIONS OF THE STUDY
The data utilized in this study are purely
secondary in nature. This covers data on All Share Index and Gross Domestic
Product which are usually from accurate in an emerging economy (Nigeria
inclusive) as a result of inadequate record keeping, and inefficiency on the
part of the official statutory agencies. Also, results from data can be baise
as a result of the imprecise measurement of variables. However, the inability
for the research to obtain a completely random sample and the smallness of the
sample size is also encountered. Effort will however be made to ensure that
these limitation are significantly reduced.